Ethical Investing - Part 2

Workers' Rights and Human Rights

Another issue that concerns ethical investors is how companies treat people, especially their workers. Many ethical investors base their definition of human rights on the UN Universal Declaration of Human Rights. The fundamental idea behind this declaration is that all people should be treated with dignity, and should enjoy the following freedoms and rights (to name just a few out of several dozen):

• Freedom of speech
• Freedom from fear
• Freedom from discrimination
• Right to life, liberty and personal security
• Freedom from slavery and freedom of movement
• Freedom from torture
• Right to recognition and equality before the law
• Right to property ownership
• Freedom of opinion and expression
• Right to peaceful assembly
• Freedom from compulsory association
• Right to work and to choose one's employer
• Right to equal pay for equal work and fair remuneration
• Right to rest and leisure
• Right to basic living standards sufficient to ensure health and well-being

An ethical investor would probably look unfavorably upon a company that made its workers feel fearful, used discrimination, slave labor or violated any of the other freedoms and rights listed above. Some companies might think it's necessary to rely on such tactics to make a profit, but wiser companies know that such behavior is shortsighted and will eventually bring the company problems.

The Business Case for Human Rights
A publication called "A Guide for Integrating Human Rights into Business Management," jointly produced by the Business Leaders Initiative on Human Rights, the United Nations Global Compact Office and the Office of the High Commissioner for Human Rights, instructs business managers on how to achieve human rights objectives while also meeting the company's financial objectives. The report identifies numerous business benefits that result from supporting human rights:

• Improved stakeholder relations
• Improved employee recruitment, retention and motivation
• Improved risk assessment and management
• Reduced risk of consumer protests
• Enhanced corporate reputation and brand image
• A more secure license to operate
• Strengthened shareholder confidence
• More sustainable business relationships with governments, business partners, trade unions, sub-contractors and suppliers

Indirect Human Rights Violations
The same publication points out that a company can have an important role in human rights violations even if it doesn't commit them directly. If the company is aware that an entity it works with (like a supplier, subcontractor or government agency) abuses human rights, the company is complicit in the abuse if it allows, encourages, tolerates or ignores that entity's behavior.

The report outlines four primary ways a company can indirectly participate in human rights violations:

1. The company provides a government with products, services or information that it knows will be used abusively.

2. The company knows that a government it is working with is likely to commit human rights violations in order to execute an agreement.

3. The company benefits from violations committed by others.

4. The company is aware of ongoing rights violations but remains silent.

Businesses can assess their strengths and weaknesses regarding human rights, and choose to eliminate their weaknesses. A company that violates human rights subjects itself to numerous risks.

Major Areas of Concern
Here are a few common areas a company should be concerned with when considering its approach to human rights.

Health and Safety in Working Conditions
An employee's working conditions will have a major impact on their quality of life, health and longevity. Dangerous working conditions include those that are unsanitary, noisy, have high temperatures, aren't adequately ventilated, have insufficient lighting, involve dangerous chemicals, are in confined spaces, demand physical labor that exceeds the employee's capabilities and entail physical or psychological abuse from other employees or managers. Employees should also have sufficient break time and access to bathrooms, and should have the physical freedom to leave the job site.

Ethical investors should know that unsafe working conditions don't just happen in other countries. In the United States, for example, a 2009 article from "Gourmet" magazine reported that tomato pickers in Florida were being held as slaves, forced to live in cramped quarters without a toilet or running water, deprived of their paychecks, refused time off when ill and physically abused. In twelve years, more than 1,000 captive workers had been freed, and more were likely undiscovered.

Health and Safety for the Surrounding Community

The health and safety of the surrounding community will be a bigger issue for some businesses than others. A retail store might not have much to worry about at its actual store, but further up the supply chain, the companies that manufacture the goods sold in the retail store might have to be concerned with their use and disposal of chemicals, for example. Agricultural operations, meanwhile, must consider the impact of fertilizers and pesticides.

Wages and Benefits

Investors have a wide range of beliefs about what wages and benefits companies should provide to their employees. Some advocate a "living wage" that pays workers enough to live comfortably in the same communities where they work. Some believe that the federally mandated minimum wage is sufficient. Still, others believe companies should be allowed to pay anything, and workers should be allowed to accept jobs at any wage, even if that pay rate is below minimum wage. Some investors are concerned about the disparity between what the company's entry-level workers earn, and what its executives earn.

Some ethical investors want to see companies offer employees a wide range of benefits. The most basic benefits are health insurance, paid sick leave, paid holidays, paid vacation and retirement benefits. Other benefits, a company might offer, include life insurance, disability insurance, stock options, an employee stock purchase plan, training and advancement programs, tuition reimbursement and flexible work hours.

Chances are you can find a company to invest in that treats its workers the way you think they should be treated. One good source of information on companies, that treat their employees well, is annual surveys of best places to work. Finding out where employees are most satisfied, and why, can help guide investment decisions.

Almost as important as knowing which companies are good choices, is knowing which companies to avoid. Watchdog organizations such as the Institute for Global Labour & Human Rights can help investors weed out companies whose treatment of workers seems unacceptable.

Corporate Governance

Corporate governance looks at how companies manage themselves and their relationships with shareholders and stakeholders. Ethical investors want to make sure that corporations are being honest and transparent, and that management isn't looking out for its own interests to the detriment of others.

Research Assistance
Investors who want help analyzing a company's governance can turn to a number of resources:

• Standard & Poor's GAMMA score (GAMMA stands for governance, accountability, management, metrics and analysis) evaluates the governance of companies in emerging markets, according to shareholder influence, shareholder rights, transparency and board effectiveness.
• Institutional Shareholder Services (ISS) has an executive compensation database, and its Governance Risk Indicators measure companies' governance performance on audit, board, compensation/remuneration and shareholder rights issues.
• The Investor Responsibility Research Center Institute funds corporate governance research, and makes it widely available to the public. For example, it published a report in July 2010 called "Compensation Peer Groups at Companies with High Pay" that examined a number of S&P 500 companies whose executive compensation was out of line with the executives' performance, and the compensation provided by similar companies.
• Governance Metrics International (GMI) develops risk ratings and research related to companies' environmental, social, governance and accounting practices. It examines all the companies in the MCSI world index, the DJ STOXX 600 and the S&P 1500, and updates its data monthly.
• Glass, Lewis & Co. helps investors evaluate the risk of investing in a company as it pertains to governance, business, legal, political and accounting issues. It also provides proxy research and voting recommendations.

Areas of Concern
Let's examine the major corporate governance issues that concern ethical investors.

Accounting
Many corporate governance issues have to do with accounting. Is the company honest and accurate in its accounting methods and disclosures? Has the company faced any regulatory sanctions, and if so, has it corrected the problems that got it into trouble?

No investor wants to hold shares of a company that commits accounting fraud, or is sloppy in its accounting practices. According to ISS, investors should be concerned if an auditor issues an adverse opinion, if the company has to restate its financials or if the company has been subject to enforcement action. Investors should also look out for the financial expertise of the audit committee and for weaknesses in internal controls.

Investor Relations
Investors are part-owners and have a financial stake in how well the company performs - perhaps not as large of a stake as the company's employees and managers, but an important stake nonetheless. Therefore, they should care how the companies they invest in treat their shareholders.

Some companies issue different classes of stock that have different voting rights, and investors in the lesser classes have fewer voting rights. In other companies, one share equals one vote. Other voting issues include whether all common shareholders have a say in the election of all board members; how the board handles popular shareholder resolutions; whether shareholders have a say in approving or denying proposed mergers, acquisitions and restructurings and whether the company has a poison pill policy. Investors want to see policies in their favor - for example, being able to vote on a proposed stock incentive plan, since too many stock options create the potential for significant share dilution.

Executive Compensation
Shareholders may want to see executive pay tied to stock performance. If the stock performs well, executives earn more; if it doesn't, they earn less. However, even if executive pay is not formally linked to performance, an underperforming CEO can be ousted in a takeover.

Some ethical investors want to limit CEO pay, to a multiple of what the company's lower-paid workers earn, but such limitations on pay may not be in the company's best interest. CEOs who are highly paid are more likely to remain with a company, and as long as they are performing well, stability can be good for the stock. Under the Dodd-Frank Act, companies must allow shareholders a nonbinding vote on executive compensation packages, and publish the results in their regulatory filings.

It matters who sits on the board of directors, how they manage their responsibilities and what other associations they have. Board members should attend at least 75% of meetings. If they sit on more than one board, they should have enough time to meet all of their obligations, and their positions should not create conflicts of interest. Ethical investors may prefer that a high percentage of the board's directors be independent; if they are not executives or otherwise affiliated with the company, they may be better able to guide the company toward choices that are best for shareholders. A CEO who is also chairman of the board creates a conflict of interest.

Regulatory Compliance
When it comes to regulations like Sarbanes-Oxley and the plethora of other Securities and Exchange Commission rules that affect companies, how does the company you want to invest in measure up? Regulatory non-compliance might pay off in the short term, but in the long run, it's likely to be detected and penalized.

Political Contributions
Sometimes companies make contributions to political candidates with the implicit understanding or expectation that if that person is elected, the company will receive some sort of special treatment from the government. Other times, companies make political contributions in an attempt to dissuade politicians from passing new regulations that would threaten their businesses. Ethical investors may not want to be affiliated with a company that engages in crony capitalism.

Illegal Behavior
A company that engages in illegal behavior puts all of its shareholders and stakeholders at risk. Types of illegal behavior that companies might engage in are insider trading, kickbacks and bribery. Sometimes it can be difficult to evaluate how problematic these practices are, because practices that are highly frowned upon in the United States, like bribery, may be essential to conducting business in foreign countries.

Governance as a Practical Matter
Corporate governance, like other matters in ethical investing, is not just a feel-good issue. It's a significant factor in determining the company's bottom line and its long-term viability.

In the next section, we'll look at how investors can take action to get publicly traded companies to change their behavior.

Investor Activism and Shareholder Advocacy

For some people, buying stocks in companies, whose actions they support, isn't enough. Activist investors seek to directly change the practices of targeted companies. As Amy Domini, founder and CEO of Domini Funds, states, "Socially responsible investing is not only a way to align your investments with your values - it is also a way to make corporations behave more responsibly." Here are the methods activist investors commonly use.

Voting
Proxies allow shareholders who cannot attend annual, or special, meetings to vote on the same issues that shareholders who do attend the meeting will vote on. Either electronically or by mail, shareholders cast their proxy ballots to make their opinions known. Typically, for every share an investor owns, he or she gets one vote. If a shareholder owns a stock class with special voting rights, he or she will get multiple votes per share.

Many investors toss out their proxy ballots because they are too busy to research the issues up for vote, and make an informed decision. Their abstention reduces the total number of ballots cast. For ethical investors, however, voting is an opportunity to be heard, and possibly to create change.

How do ethical investors know which way to vote on the issues? Often, they look to more experienced investors for guidance. For example, institutional investors might publish proxy voting guidelines on their websites, explaining how they chose to vote and why. Investors can decide to vote with the institution or against it, depending on whether they agree with the institution's position or not.

Institutional investors can have a great deal of influence on the outcome of elections, because their large size allows them to own large numbers of shares. Therefore, it may take a consolidated effort from large numbers of small-time investors to influence a vote's outcome. Ethical investors are most likely to have an impact if they join a coalition of like-minded investors.

Socially responsible mutual funds' published proxy voting policies are also a good source of information for individual shareholders. For example, the "Calvert Family of Funds' 2010 Global Proxy Voting Guidelines" states that Calvert espouses the following positions:

• The Fund advisor will oppose non-independent directors candidates nominated to the audit, compensation and/or nominating committees.
• The Fund advisor will oppose executive compensation proposals if we determine that the compensation does not reflect the financial, economic and social circumstances of the company (i.e., during times of financial strains or underperformance).
• The Fund advisor will ordinarily support proposals requesting that companies avoid exploitative labor practices, including child labor and forced labor.

Shareholder Resolutions
To take things a step further, some investors introduce their own issues to vote on. These are called shareholder resolutions, and in order to propose one, you must have a meaningful stake in the company. The SEC defines this stake as 1% of all outstanding shares, or $2,000 worth of shares, held for at least one year prior to the resolution submission deadline.

The resolution itself must follow specific guidelines in order to be accepted (e.g., it can't be longer than 500 words). Also, the person or group (or their representative) who files the resolution, must attend the meeting to present the resolution. Companies don't have to accept resolutions, and even if they receive a majority vote, they don't have to implement them. However, shareholder resolutions give investors a chance to present their ideas to companies and to other shareholders. Also, shareholder resolutions may garner media attention that can pressure companies to make changes.

What kinds of changes do shareholder resolutions seek? Some ask corporations to disclose information about their impact on the environment. Others ask corporations to make a specific change, such as taking an action that would decrease the company's waste production. Shareholder resolutions allow investors to influence company policies, and bring to their attention to issues, that, if not addressed, could adversely affect shareholder value.

Electing New Directors
Ethical investors can try to get board members, whose views they disagree with, replaced by board members whose views they do agree with. The policies for nominating directors vary by company, but can be found in the company's proxy statement. However, a company may not even look at a nomination from an unknown shareholder, let alone take it seriously. Companies already have established procedures for locating prospective board members.

In recent years, activist investors have pushed for open nomination policies to get their suggestions put on the proxy ballot. Such a policy would publicize nominations and put them to a vote. However, in July 2011, the U.S. Court of Appeals ruled against a proposed SEC rule that would have allowed shareholders, owning at least 3% of outstanding shares for at least three years, to put their nominees on the proxy ballot.

Divestment
A single individual selling a few shares of a company to protest its practices is unlikely to have any effect. Getting a significant percentage of shareholders to do so, however, may put enough pressure on a company to convince it to change. To succeed in this strategy, it is usually necessary to win over institutional investors.

Divestment is considered a last resort, after other methods of shareholder advocacy have failed, and it is usually only used in extreme cases. The most famous example is that American students in the late 1980s convinced some universities, whose large endowments classified them as institutional investors, to sell their shares in companies tied to South African apartheid. Other large investors, including some city, county and state governments, followed suit. It's difficult to say whether divestment created enough economic pressure to force South Africa's rulers to change their ways, but it certainly brought increased attention to the human rights abuses occurring in the country.

How To Research Ethical Investments

 

Researching ethical investments means examining both company ethics and investment performance. Let's start with ethics.

Perusing Corporate Websites
It seems like every corporate website, these days, has a section on sustainability. But can you believe what you read? When are a company's practices truly sustainable, and when is the promotion of sustainability just a public relations strategy? Let's examine how you can get to the truth.

If you want to invest in individual stocks, company websites aren't a bad place to start your research. Publicly traded companies generally have two websites - a consumer-focused website and an investor-focused website. The investor-oriented site is where you'll most likely find the information you seek.

Here are some examples of the types of information you're likely to find:

• Community Impact
  Walmart states, "we believe in a philosophy of operating globally and giving back locally. . . . [we help] to provide financial and volunteer support to more than 100,000 charitable and community-focused organizations."
• Commitment to Workers
  Google states, "We provide a standard package of fringe benefits, but on top of that are first-class dining facilities, gyms, laundry rooms, massage rooms, haircuts, carwashes, dry cleaning, commuting buses - just about anything a hardworking employee might want."
• Environmental Responsibility
  Clorox states, "The Clorox Company is committed to minimizing hazardous waste in its facilities. We ensure that any waste that is generated is properly handled by approved vendors and that it is properly tracked throughout the process."
• Human Rights
  Gap states, "Gap Inc. seeks to ensure that the people working at various points along the supply chain are treated with fairness, dignity and respect - an aspiration that is born out of the belief that each life is of equal value, whether the person is sitting behind a sewing machine at a factory that produces clothes for Gap Inc., working at one of our stores, or wearing a pair of our jeans."

Be cautiously optimistic, though: companies know that by promoting the ways that they protect the environment, benefit the communities where they operate and more, they may attract increased numbers of customers and command higher prices for their products. So it's safe to assume that if a company has any ethical practices, whatsoever, it will promote them on their website. Unfortunately, it's also true that companies that aren't particularly ethical sometimes cover up, or stretch, the truth to promote a positive image of themselves. That's why you shouldn't rely, entirely, on what a company says about itself on its website - you should verify the information with reliable third parties. For example, look for news articles on the company's activities, and make sure that the articles haven't just relied on the company's own press releases and internal data as sources.

Screening Tools
There are also websites and companies that will help you screen for socially responsible investments. They've done the hard work for you and can save you some time. Here are some examples.

• The American Customer Satisfaction Index (ACSI) is not specifically geared toward socially responsible investors, but it's a useful tool for locating companies that customers are happy with and, that, consequently, are probably doing well financially. The ACSI evaluates more than 225 companies in 47 household consumer industries, looking at customer expectations, perceived value, perceived quality, customer complaints and customer loyalty to determine how satisfied customers are with a company.
• The Social Funds website's Corporate Research Center lets users search for companies by name to find independently produced social responsibility profiles of those companies. For example, the site will help you locate a report on Amazon produced by Calvert (a socially responsible investment company). Site visitors will also find recent news related to sustainable investing.
• The Global Reporting Initiative (GRI) website gathers corporations' own corporate social responsibility reports. GRI developed a sustainability reporting framework to guide companies on the issues the public may want to know about, such as the monetary value of any environmental fines a company has paid, the number of company contracts that have undergone human rights screening and the percentage of employees covered by collective bargaining agreements.

You can also use the list of companies that make up a socially responsible mutual fund, or ETF, as a starting point to select individual stocks.

f you're looking for socially responsible mutual funds, a number of screening tools will help you find the right fund to achieve your goals. Exclusionary screens weed out companies, and funds, which invest in things you don't like, while inclusionary screens find companies, and funds, that invest in causes you support.

• Calvert's Know What You Own service lets users look up any mutual fund (not just Calvert funds), choose an issue that's important to them and then see which companies in that fund (if any) do not meet their criteria.
• The Calvert Social Index starts with the 1,000 largest companies in the United States by market capitalization, and narrows down the list by evaluating each company's performance in the areas of government and ethics, environment, workplace, product safety and impact, community relations, internal operations and human rights and indigenous people's rights. The company also offers a number of other stock, bond and money market funds that are more tightly focused on specific social goals or financial goals.
• The Forum for Sustainable and Responsible Investment helps individual investors compare socially responsible mutual funds by cost, performance, screens and voting records. "Bloomberg" provides the financial performance data. Users can graphically see whether a fund excludes investments in certain categories (such as defense/weapons), seeks investments with a positive impact in certain categories (such as labor relations) or seeks to avoid poor performers in certain areas (such as human rights).

Once you've determined that a company meets your ethical criteria, it's time to see if it meets your financial criteria (you could also do these steps in reverse order - start with whichever one is easier for you). You can use the same methods traditional investors do, to evaluate an investment's financial performance, such as annual reports, prospectuses etc.

Benefits And Drawbacks Of Ethical Investing

There are many reasons to pursue ethical investing - and many reasons why people avoid it. Here, we take a closer look at their motivations.

The Feel-Good Factor
Ethical investing certainly has a large emotional component. People who choose to follow an ethical investing strategy let their feelings, about how workers should be treated, how the natural environment should be cared for, how corporations should treat their shareholders and so on drive their investment decisions. One of the benefits of this style of investing, is the potential for good feelings when a company, whose actions you support, performs well financially, bringing good returns to your portfolio, and benefits to all of its stakeholders.

The downside of this emotional component is that if a company violates one of the principles you thought it stood for, can bring massive feelings of disappointment. The same thing can happen if the company's principled stance fails to bring good financial returns, or even brings financial losses.

Compounding the Effects of Everyday Choices
If you already live your life in strict accordance with a particular belief system, ethical investing is a logical addition to that system. The decisions that large corporations make have a much bigger impact than the decisions that one person makes, after all. It doesn't make a lot of sense to ride your bike everywhere, and only use canvas bags for your groceries while holding shares in a company with a poor environmental record. Of course, if you're an average investor with a few shares, or even a couple hundred shares, you're too small to have much influence on a company, but you'll probably sleep better at night knowing that your investment choices are aligned with your living principles.

Deciding Where to Draw the Line
It can be difficult to find investments that perfectly meet your criteria, which means that you have to decide what's most important for you and where, if anywhere, you're willing to compromise. What if 5% of a company's operations involve something you don't approve of, and the other 95% in something you do? Do you invest? What if you like a particular company, but you don't like its parent? What if you invest in a company you support, and then it gets purchased by a company you hate? If you have to choose a lesser evil, why invest at all? What about socially neutral investments - do they have a place in your portfolio? You have to overcome difficult decisions, like these, if you want to be an ethical investor. Not investing isn't an option if you want to be financially successful.

Forgoing High Returns from Investments that Don't Meet Your Criteria
When you screen out investments that don't meet your environmental, social or governance criteria, you'll inevitably be screening out some high performers. You won't necessarily earn lower returns by pursuing an ethical investing strategy, but it will take more work to track down the right investments.

Expending Time and Effort
Socially responsible investing is not a passive strategy. It takes a lot of time and effort to track down and review all the research you'll need to make your decisions - more time and effort than it would take if you were solely focused on financial performance. Once you've found investments you like, you have to keep tabs on them to make sure they meet the ethical and financial goals you expect them to. Sometimes you'll have to sell investments that fall short and find new ones to replace them. If it all sounds like so much work that you feel totally discouraged from investing at all, you might want to invest conventionally and commit to donating a percentage of your profits to charity.

Overcoming High Fees
If you choose to invest in socially responsible mutual funds, you might have to overcome higher expenses than you would as a conventional investor. Essentially, what you're paying for is to have someone do all the difficult research on ethical and financial performance for you. If you're busy and if you trust the mutual fund company, this price may well be worth it. But high expenses can really drag down your returns, especially over the long run. Will you still be able to meet your financial goals if you're paying expenses of 1.2% annually instead of 0.2%?

Going Against the Tide
Socially responsible investing is still a small part of the overall market. The majority of investors don't decide what to buy or sell based on the same criteria that socially responsible investors use. Lots of investors don't give much thought about what they invest in - they just choose the options that their 401(k) manager recommends given their anticipated retirement date, or they pick an S&P 500 index fund and forget about it. Once again, you'll have to work harder to find the news and information you'll need to make your investing decisions - you may not be able to find it in conventional financial reporting sources.

Courtesy : Investopedia