SRI: How Does It Work?

The goal of asset management is to yield a profit by investing money in securities. For this purpose, the asset owner – an institutional or individual investor – can choose either to manage the assets or to entrust the money to a professional asset manager. A management of assets which is outsourced to an asset management company is known as third-party management. Asset management companies earn income by charging service fees to their clients. There are two types of third-party management:

Investment funds which are categorized as OPCVM (Organismes de Placement Collectifs en Valeurs Mobilières)⁹. They are savings vehicles which give investors part-ownership of a portfolio of securities (shares, bonds, et cetera) held jointly with other investors. All OPCVM are subject to supervision by the AMF and follow specific rules, such as the spreading of risk and transparency.

Individual management mandates which enable investors with sufficient funds to obtain customized management of their assets. Under this arrangement, investors grant the manager power of attorney to manage their investment portfolio.

Throughout the remainder of this dissertation, SRI will only concern third-party management conducted by asset management companies in equity and fixed-income investment. Equity investment refers to the buying of shares in anticipation of the increase in their market value.

Fixed-income investment consists of lending money to a borrower, who has to regularly pay interest and reimburse the loan after a fixed time. The term „fund‟ will be used indifferently for investment funds and individual management mandates. A fund is defined as „an entity which collects the money of one or several investors (institutional or individual) in order to invest it in transferable securities (shares or bonds)‟. A portfolio relates to the composition of the fund in terms of companies.

To achieve the two objectives of SRI funds (i.e. to select the most socially responsible companies and to achieve better financial performance), the French asset management sector organized itself as illustrated in figure 0.1.

9 Organizations for Collective Investment in Transferable Securities

Figure 0.1: Organization of the French Asset Management Sector Regarding SRI

An SRI fund differs from a conventional fund by the fact that it is usually held accountable both on its financial and SRI performances.¹⁰ Financial performance is typically assessed in terms of financial returns on investments. Namely, the tracking error is used to measure how much the return on a portfolio deviates from the return on its benchmark index.

At present, SRI performance has not yet been defined. Assessment of SRI performance mainly depends on the motivation of asset management companies to account for the non-financial dimensions of their investment processes. However, two main types of criteria are usually employed by the sector: SRI grade and SRI selectivity. SRI grade refers to the SRI grade of a portfolio obtained by adding up the SRI grades of each company present in the portfolio. SRI selectivity relates to the proportion of companies excluded from the portfolio only for SRI reasons. SRI grades are provided by buy-side (i.e. inside asset management companies) SRI analysts. An SRI analyst is a financial analyst‟s equal regarding SRI criteria.

SRI criteria relate to non-financial analysis, such as environmental, social and governmental criteria. An SRI grade reflects the rank of a company in its activity sector, regarding SRI concerns. For instance, in a sector, a company whose SRI grade is 80/100 is considered to be

10 At the very least, an SRI fund usually describes the non-financial criteria used in its investment process.

more socially responsible than a company whose SRI grade is 70/100. To build these grades, buy-side SRI analysts rely on information provided by social rating agencies and brokers.

Social rating agencies are companies specialized in non-financial analysis (sell-side), which sell SRI analysis to asset management companies. Brokers execute instructions from buyers and sellers of investments. They charge a commission on trades but offer complimentary financial analysis (sell-side) to their clients. Part of this financial analysis concerns SRI analysis.

Inside asset management companies, SRI analysts supply their SRI rankings to asset managers, who decide where and when to invest according to the fund‟s „investment policy‟.

To make their decisions, asset managers rely on the SRI rankings provided by SRI analysts and on financial analysis provided by brokers. In major asset management companies, they may also work with buy-side financial analysts. Support Functions, such as Middle and Back Office, execute orders. Lastly, the Development Department sells funds to investors. The second article of the dissertation, „Transforming Practices in Response to Institutional Change – Exploring the Role of Objects‟, and the third article, „Explaining Practice Variation When Faced With Institutional Change: The Example of Socially Responsible Investment‟, give further explanations about the workings of an asset management company in practice.

Three other actors play an important role in the development of SRI in France:

consultants, Novethic and the CIES. Consultants help institutional investors to select SRI funds. In doing so, they directly participate in the framing of client demands. One of the objectives of Novethic is to favor the development of SRI in France. It is the only organization which provides a public assessment of SRI funds. Lastly, the CIES is a committee, gathering four of the five representative French trade unions, which provides an SRI label to a range of employee saving funds. Due to the lack of regulation of SRI, asset management companies are urged to meet the demands of these three actors to be able to sell SRI funds.

The market has become increasingly competitive over the past ten years. At the end of 2009, there were 268 SRI investment funds proposed by 65 asset management companies,¹¹ working with more than 20 social rating agencies. Whereas SRI funds originated from equities, in 2008, SRI equity funds represented only 33% (against 43% in 2007) of the total assets of SRI funds; 67% concerned fixed-income SRI funds. This proportion is slightly

11 This proportion refers to the assets managed by the French OPCVM. Source : Novethic www.novethic.fr

different from the usual breakdown of assets adopted by institutional investors. Indeed, benefit institutions and insurance companies usually invest between 80 to 90% of securities in bonds and 10 to 20% in equities (Pras and de la Lande, 2009). Today, SRI funds are said by Novethic to represent between 2 to 3% of the French assets under management. However, this small proportion hides a much larger trend: the progressive and massive integration of SRI criteria into the mainstream. At the end of 2009, this new phenomenon, known as SRI Mainstreaming, concerned 90% of conventional funds in terms of assets (Novethic, 2010).