COLUMN-Green indices muddy sustainable investing-Gerard Wynn

Thu Sep 22, 2011 10:47am EDT

(Gerard Wynn is a Reuters market analyst. The views expressed are his own)

By Gerard Wynn

LONDON, Sept 22 (Reuters) - Sustainability data can help spot winners in a future, greener economy, but only with active political lobbying to abolish fossil fuels subsidies, for example, as sagging equity markets revive talk of alternative investment approaches.

Environmental social and governance (ESG) data measure performance in areas like health and safety, labour rights, corruption and transparency on carbon emissions reporting.

ESG leaders can out-perform in equity markets, as related indices point to quick-witted, high-achieving companies.

The rapid response of Puma, Adidas and Nike to Greenpeace demands to halt discharge of toxins into Chinese rivers illustrated ESG awareness in leading companies.

Such companies want to be seen as green, but whether they are is more complicated.

That uncertainty is reflected in broad ESG indices which may claim to be sustainable but use broad criteria which could please many but fail to capture anything precise.

The UK green group Forum for the Future and the investment arm of insurers Aviva PLC published a report this month which tried to capture what types of companies would flourish in a sustainable economy of 2040.

Such companies may underperform now, given government policies and resource limits may still disadvantage them.

The low-carbon sector, one narrow aspect of ESG, has underperformed oil and gas and wider benchmarks, see chart below.

Active lobbying must accompany sustainable investing: G20 governments pledged to abolish fossil fuel subsidies two years ago, but that promise is unfulfilled despite prodding by the International Energy Agency (IEA).

The Aviva/Forum for the Future report pictured how five key sectors - food, health, energy, mobility and finance - should look in 30 years time, for example in resource efficiency and social justice.

TOP TEN

Broad green indices apply sustainability criteria across a wide range of stocks, to catch a wide, investable mix. The approach can yield inconsistent results.

The Carbon Disclosure Project (CDP) has over the past nine years successfully pressed the world's biggest companies to reveal environmental strategies by sending a questionnaire and publishing the answers.

In its global 500 report last week, it suggested "a strong correlation" between returns on investment in a company's shares and an index which measures corporate fulfilment of emissions targets.

The top leaders in the index were Philips Electronics, BMW, Honda Motor Company, Tesco, Bank of America, Westpac Banking Corporation, Bayer, Cisco Systems, SAP and Sony Corporation.

Philips and Cisco are positioning in energy efficiency but it's hard to explain all these low-carbon leaders.

Among automakers, BMW makes just two and Honda none of the 72 low carbon-emission models qualifying for zero road tax in Britain, according to the Vehicle Certification Agency.

The Dow Jones Sustainability Index (DJSI) identified three identical companies including Philips and BMW in its 19 "supersector leaders", based on a broad questionnaire ranging from gender equality to remuneration transparency.

The DJSI has performed well compared with world stocks.

SYSTEMATIC

How to make indices, or ESG data, deliver something more precise is the challenge.

A sector-specific approach, for example focused on wind, solar or energy efficiency, runs the obvious problem of a less liquid group. HSBC has selected companies which make revenues from climate change-related themes, for a broader base.

But sector approaches also risk losing broader sustainability themes such as corporate governance and social responsibility, and dropping ESG leaders. Governance in particular, the checks and balances of how a company is run, is key to performance.

Active investors argue that in sustainability, in particular, a discriminating, hands-on approach is needed, using ESG data and FTSE Group-type scoring to spot companies more likely to thrive in a sustainable world with tougher social governance and environmental laws. (Editing by Jason Neely)