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Institutional Investor looks at Socially Responsible Investing:

Watch videos of II's Executive Editor, Mike Peltz, and reporters, Imogen Rose-Smith and Katie Gilbert.

Read Katie Gilbert’s story about SRI 2.0 – today’s socially responsible investing model.

Click through our slideshow of images from the Compass Conference on SRI.

Growing up in the 1960s and early ’70s, Kerry Kennedy (pictured below, left) spent her summers on Cape Cod, in Hyannis Port, Massachusetts, with her many siblings and cousins at the ­Kennedy Compound. The three homes that make up the compound, located on six neatly manicured acres alongside Nantucket Sound, are still owned by the Kennedys, who descend on the Cape every summer. This year was no different, except that Kerry, the seventh of Robert and Ethel Kennedy’s 11 children, persuaded her family to open its doors for three days to a serious cause: expanding fiduciary responsibility.

That’s how a group of some 150 people — among them, 31 fiduciaries representing some of the U.S.’s largest public pension plans, including the California Public Employees’ Retirement System, the Florida State Board of Administration and the North Carolina Retirement Systems, as well as corporate pension plans, sovereign wealth funds, university endowments and foundations — found themselves invited to the Kennedy Compound in late July. Ethel Kennedy greeted the guests, who sneaked glances at the family photos that clutter almost every surface of her longtime residence and chatted with other members of the clan, including Kerry’s brother Bobby Jr. and cousin Ted Jr., before wandering out onto the wooden deck. From there they made their way inside a large tent, decorated with strings of twinkling lights, where dinner, featuring New ­England clam chowder, was served.

James Wolfensohn (pictured right), former head of the World Bank and a longtime friend of the Kennedys, gave the keynote address. The world, the veteran investment banker told his audience, is changing fast. In 30 years as much as half of global GDP will come from India and China, he said. “And the thing is that, for those of us that live in the currently viewed rich world, thi s is a change of proportions that our generation has never seen before,” he explained. “The change in itself is dramatic in terms of numbers, but the most dramatic change is what’s going to happen in the economics. And it’s not just in the economics; it’s what is happening socially and intellectually in those countries.” In this new world order, Wolfensohn suggested, fiduciaries will need to rethink not only where they put their money but how they invest and what they value. In short, they are going to have to focus on investing for the global good.

The evening kicked off the first RFK Compass Conference, organized by the Robert F. Kennedy Center for Justice & Human Rights, the not-for-profit organization founded in 1968 by the late Robert Kennedy’s family and friends to carry on his legacy. Kerry, president Orin Kramer of the RFK Center, and a group of its supporters — including Orin Kramer (pictured left), a hedge fund manager and New Jersey State Investment Council board member; Marc Spilker, former co-head of Goldman Sachs Asset Management; and Robert Smith, founder and CEO of $3 billion, San Francisco–based private equity firm Vista Equity Partners — put the conference together because they believe that issues of environmental impact, socially responsible investing and corporate governance, which commonly go by the label ESG, are more important than ever for investors.

“This is not something that is abstract,” says Kerry Kennedy. “These are real issues that fiduciaries are dealing with every day.” The recent economic meltdown, she says, is just one factor causing investors to step back, take a look at what they do and realize just how important ESG considerations really are.

Some might puzzle over why a human rights organization like the RFK Center cares what an institutional investor like the New Jersey state pension system does with its money, but for the center’s supporters, this makes a lot of sense. “Kerry got together a group of people who were really inspired by her, and we’re doing this for her and to support her work in human rights,” says Kramer. Adds Spilker, “The mission of the RFK, doing social justice and human rights, is one of the truly honorable things in the world to be doing.” Expanding fiduciary responsibility to include ESG factors, he says, could have a much bigger impact than any on-the-ground initiative that the center might undertake. “If the entire investment landscape changes by one small little fraction, the impact could be on hundreds of millions of people,” Spilker explains.

Spilker, Kramer and Kennedy insist they are no Bambi-eyed idealists. But until recently, mainstream asset managers considered them to be exactly that. Now, however, the brain trust behind the Compass Conference is among a growing number of investmen Orin Kramer t professionals and thought leaders who believe that pension plans and other institutions have a fiduciary obligation to consider ESG factors when they invest. In fact, they say, consideration of such principles is critical to successful long-term asset management — an argument that has gotten a boost from recent events, including the economic meltdown, the BP oil well disaster and the Massey Energy Co. mine explosion, as well as from growing evidence of the impact of climate change and the importance of good corporate governance.

“A fiduciary with an investment vehicle like a pension fund or endowment with a long time horizon should be thinking about conditions that will affect investment returns over ten to 30 years,” says New Jersey’s Kramer.

Institutional investors have historically not considered ESG factors to be important; most believed looking at these issues to be at odds with what they did. Traditionally, the most common way to approach ESG factors has been through so-called socially responsible investing, or SRI. In its earliest form, SRI consisted of screening out “bad” securities, like the stocks of tobacco makers or companies that manufactured land mines. For many of the pioneers of Modern Portfolio Theory — an investment approach, favored by institutions, that emphasizes diversification — such screening was foolhardy.

“It is hard to do well by doing good when you shrink your opportunity set,” says Mark Anson, a former CIO of CalPERS. “In fact, mathematically you are wrong.”

A rain forest of academic literature published on SRI indicated that, at best, screening had no impact on returns. Many continued to believe, sometimes with good reason, that socially responsible funds underperformed the market. As a result, SRI was relegated to a group of values-driven investors — religious organizations, hospitals and the like. Without role models among mainstream investors, public pension funds in particular were reluctant to consider what in the past half dozen years came to be termed ESG.

Socially responsible investing was also dogged by an all-or-nothing attitude. “There was this sense that you couldn’t be a little bit pregnant,” says Lyn Hutton, CIO of Wilton, Connecticut–based ­Commonfund, which manages $25 billion in foundation and endowment assets. This led many institutions to throw up their hands. “A lot of investors got stuck in these abstract conversations,” says John Goldstein, co-founder of Imprint Capital Advisors in San Francisco, one of the only consulting firms to focus exclusively on advising investors on ESG and other impact investments.

But as the discussion shifts from screening out bad stocks to using ESG factors to identify investment opportunities, a new pragmatism has kicked in. “Forget about winning the war, let’s just win some battles,” says Goldstein. “Getting people to fundamentally change how they think about investment management is a pretty large task. Getting them to invest in a fund with a proven track record is easier.”

Now some foundations are looking at whether to invest in the initiatives they encourage with their grant making. This so-called mission-based investing can help lay the groundwork for a broader approach. “There are some really interesting things happening, lots of community investment across the country,” says Christa Velasquez, director of social investments at the Baltimore-based Annie E. Casey Foundation, which has allocated $125 million of its $2.5 billion in assets to investment funds directly tied into the foundation’s objective: improving the lives of vulnerable children in the U.S.

Two years ago, Annie E. Casey was one of three foundations to support the formation of a mission-relating investing initiative at Cambridge Associates, a Boston-based consulting firm that advises more than 800 endowments, foundations and other not-for-profit institutions worldwide. And, in a major breakthrough, a handful of investment consultants are now beginning to take responsible investing seriously. It helps that a group of money managers — London-based Generation Investment Management foremost among them — is starting to prove that looking at so-called sustainability issues can be profitable.

Outside the U.S. many large investors already take ESG extremely seriously. It has been five years since the Caisse de dépôt et placement du Québec implemented its policy for responsible investing, which, put simply, pledges the $192 billion Canadian sovereign wealth fund to incorporate ESG principles in its investment approach. “For us, the financial mission and the nonfinancial mission go hand in hand,” says Roland Lescure, Caisse’s Montreal-based CIO. “It is not a duty that we have on top of our financial responsibilities.” Responsible investing is part of Caisse’s core approach, even if the investment impact of some ESG measures is hard to quantify. “It is both a risk management and performance enhancement tool,” Lescure says.

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