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September 24, 2004
Institutional Investors Can Now Hedge Climate Risk With New Investment Strategy
by William Baue
The strategy combines the investment algorithms of State Street Global Advisors with an
environmental overlay from Innovest Strategic Value Advisors.
SocialFunds.com --
Institutional investors concerned about the impact of climate change on portfolio performance
gained a new tool yesterday when State Street Global Advisors (SSgA) and Innovest Strategic Value Advisors launched their US Core
Environmental strategy. The strategy grows out of an SSgA study finding benchmark outperformance
by applying its own proprietary investment algorithms, and further outperformance by adding a tilt
based on Innovest's sector-specific environmental ratings.
"SSgA believes that its process adds value to the
benchmark, and the study showed it does, but what the study also showed to their satisfaction is
that Innovest's process is accretive, so you get a double hit," said Innovest CEO Matthew Kiernan.
"I like to call it a 'double alpha' strategy."
State Street, which has about a three
percent ownership stake in Innovest, focused the study on a broad universe comprising the Russell
1000. The study examined a five-year period running from December 1998 to February 2004.
"We found 1.81 basis points in incremental annual performance improvement when we incorporated
Innovest environmental information relative to the same quantitative strategy without environmental
inputs," said Kimberly Gluck, a principal at SSgA. "We ran simulations using a number of different
techniques, all of which added value."
Mainstream investors have long responded to studies
finding SRI outperformance by attributing it to other factors, such as overrepresentation of
technology stocks (during the tech boom) or exposure to interest rate fluctuations.
"What
this study did, importantly, is to normalize away all of those potentially intervening variables
and isolate the SRI effect," Dr. Kiernan told SocialFunds.com. "We think precisely because this
strategy combines sustainability with a disciplined traditional process that it is likely to
resonate much more strongly with institutional investors, who are understandably concerned with
their fiduciary responsibility."
In fact several members of the Investor Network on
Climate Risk (INCR), a coalition of
institutional investors representing over $800 billion in assets, are currently gearing up to apply
eco-efficiency screens to portions of their portfolios.
The California Public Employees
Retirement System (CalPERS), the largest
US pension fund with $166 billion in assets, is perhaps furthest advanced in translating INCR
principles into concrete actions over and above shareowner action. In April 2004, the CalPERS
Board approved implementation of the "Green Wave Initiative" proposed by California Treasurer Phil
Angelides. Earlier this month, CalPERS issued a call for investment managers to manage up to $500
million in environmental investment strategies.
Asked whether CalPERS is considering
employing the SSgA/Innovest US Core Environmental strategy, CalPERS spokesperson Brad Pacheco told
SocialFunds.com that "it's too early for us to comment."
The Green Wave Initiative
inspired Maine
Treasurer Dale McCormick to develop a similar model.
"I am in the process of
formulating a proposal to accommodate my 'Two Percent Initiative,' which is investing 2 percent of
the Maine Trust Funds in securities that would hedge against climate change risk and leverage the
competitive advantage of eco-efficient companies," Treasurer McCormick told SocialFunds.com. "The
announcement of this strategy is very timely--I was expecting State Street would apply, though when
I formulated my initiative, they hadn't launched their fund yet."
Now, details on the
fund are available.
"SSgA's US Core Environmental Strategy seeks to outperform the S&P 500
Index by 2 to 4 percent annually regardless of market conditions," Ms. Gluck told SocialFunds.com.
"Unlike many socially responsible strategies, the US Core Environmental Strategy does not eliminate
whole industries or individual companies from the investable universe, thus removing a major
obstacle to institutional acceptance of an environmentally-sensitive strategy."
Interest
will likely not be limited to INCR members, as a wide range of institutional investors are shifting
from the traditional view that fiduciary duty prohibits consideration of environmental
issues to the view that prudence requires such consideration.
"We believe there has
been a tectonic shift in the US institutional market over the last nine months whereby formerly
divergent issues--sustainability on the one hand, and corporate governance and fiduciary duty on
the other--are beginning to converge here," said Dr. Kiernan.
"For endowments and
foundations that value the environment, this strategy gives them an opportunity to make the
investment side of their operation congruent with their program activities," Dr. Kiernan added.
©
SRI World Group, Inc. All Rights Reserved.
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