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By Christine Kole Maclean

Ten years ago, socially responsible investing essentially meant that a fund was divesting from South Africa. While today South Africa is still an issue in the fray, baby formula, food irradiation, world debt, and farming are representative of the variety of issues that conscientious funds are called on to consider.

Finding the way through the maze of issues can be a daunting task, and funds have come up with different formulas and processes to get the job done. Some brief their managers on what social spin to put on the proxy, then let them vote all issues; others allow managers to vote routine issues but reserve the right to vote on more complicated social issues. Other funds have proxy voting committees, which, during proxy season, review issues on a case-by-case basis and then make decisions based on their discussion and analysis.

According to Trex Proffitt, a research analyst for the Investor Responsibility Research Center (IRRC), private universities with large endowment funds in particular like the committee system because it allows them to give proper consideration to all the issues and because the guidelines provided by the committees to the money managers are usually nonbinding. "It allows the university to express its moral outrage regarding social concerns, but still remain invested," explains Proffitt. "They win because they keep a clean conscience, and the [investment interest] wins because it doesn’t have to suffer embarrassing divestments."

Smaller funds, like state universities and schools, may not have either the interest in or the resources to form these committees because of the expense and time involved, says Proffitt. Instead, they often "wait for the ground swell of interest to become so great that it justifies action."

If committee systems are at one end of the social issue spectrum and money managers as decision-makers are at the other, then the University of Michigan endowment fund, with investment assets that total about $1.2 billion, falls somewhere in between. The U-M regents, the body that determines the "broad strokes" of how the endowment assets are invested, decide which issues become policy, based on input that can come from different groups, according to Norman Herbert, chief investment officer at the U-M.

The impetus for action usually comes to the regents through three avenues. The investment office, which closely monitors the issues, can suggest a policy change to the vice president and chief financial officer who then reviews the suggestion and takes it to the regents if he thinks the situation warrants it. Another option is that the senate committee on financial affairs, made up primarily of faculty members, could advise the vice president-chief financial officer of an issue that needs action and he may choose to take it to the regents.

Finally, "any member of the community in the broadest sense—could be a faculty member, a student, a resident of Ann Arbor, or an alumni—can attend a monthly comment session which is provided to bring that sort of thing to the regents’ attention," says Herbert. The regents then take whatever action they deem appropriate.

So far, South Africa is the only issue that has become policy at the U-M. In fact that issue is the one that forced many funds to set up a structure and process to handle socially responsible investing concerns. Up until 1977, for example, the U-M regents voted in favor of management on every proxy issue, says Herbert. But when student groups started putting pressure on the administration to divest, the regents turned to an existing committee, the senate assembly advisory committee on financial affairs to the vice president-chief financial officer (which is made up of both faculty and students), and asked it to review the issue. That set a precedence for how other social issues will likely be handled in the future. When the regents are confronted with another social issue, it’s reasonable to assume that again they will ask a committee to examine the facts and present their findings, says Herbert.

Today the U-M abstains on all proxy issues except South Africa. "We’re not taking a position [on the rest of the issues] because we don’t know how to represent the community as a whole—because we respect the different opinions that exist on campus," says Herbert. The investment office gets its direction from the regents; meanwhile the regents wait for direction from the community on any given issue.

Herbert points out that this procedure may explain why the university appears to be less than progressive on issues like the environment or Northern Ireland: "I’m not saying that [those issues] are not there. I think there are probably interest groups, but [their issues] have not been brought to the attention of the regents. We’re sensitive and know what’s going on . . . like Nestle’s infant formula and TV violence—things that might not even appeal to interest groups right now."

The South Africa issue was important to the university even beyond being the impetus to create an internal procedure for social issues: the U-M used it as a test case on the issue of autonomy. In 1982, a year before the regents adopted their own "out of South Africa" policy, the state of Michigan adopted legislation stating that no public university could invest in companies that did business in South Africa. However, "constitutionally, the regents are provided full management responsibility for the U-M, so this impinged on that authority," says Herbert.

The university partially divested but then challenged the ruling by continuing to invest in certain Michigan-based companies that had a significant number of employees (defined as more than 500), even if they had some holdings in South Africa. "Part of the thinking there was that we wanted to continue to provide support in the state," says Herbert. "From a strategic standpoint, it allowed us to continue to hold investments in companies that do business in South Africa while we challenged the state. We had to maintain a holding position in order for the state to consider us in violation of their legislation." In the end, the university won and then, according to its own policy, completed its divestment in 1984.

The university currently uses the broadest definition for determining whether or not a company is "in" South Africa: "Even if there were one employee, we wouldn’t invest. Even a representative of American Express, for example, would constitute doing business in South Africa and preclude our ability to invest," says Herbert. "As long as [a company] doesn’t have any representatives over there or an operation, we can invest." In keeping with the IMC, the policy is "silent" on licensing, Herbert adds.

Herbert says that divesting brought with it a few challenges, not the least of which was identifying managers who had a good track record when it came to managing South Africa-free portfolios. Few, if any, managers had worked under that constraint. "To the extent that you were now going to go ask a manager to do what had not been done before, it was a risk," he says.

Using the power of deducement, the fund bypassed this obstacle. Since the companies doing business in South Africa at that time were generally multi-national and large capitalization, it stood to reason that money managers that specialized in small- and medium-cap investing would be the most qualified—at least at that moment—to run South Africa-free portfolios.

Herbert believed that if they could identify managers with that style, divesting wouldn’t irreparably damage the portfolio because "small- to medium-cap companies tended to perform better in terms of their yield and appreciation over long periods in time than the [large-cap] companies" in the long run. He concedes that there are "snapshots" where that is not the case, but "looking at studies that were available, you could expect that because of holding small or medium size companies in the portfolio, you could look for those to provide as much as 300 basis points better performance than large-cap companies."

Making sure that those managers implemented the South Africa policy was another matter—albeit a relatively easy one—that needed attention. The fund relies on the IRRC, which does a constant surveillance of social issues and of companies doing business in South Africa, for status reports. The IRRC directories and updates are reviewed as they are received—at least once each month—and any time a company that’s in the portfolio shows up on the South Africa list the investment office notifies the appropriate manager and requests that the manager dispose of it "in a prudent way," says Herbert. "We don’t tell the manager to sell right away. We let them assess what the situation is and sell in a prudent period of time." Within a quarter the investment office checks on the money management firm to make sure it has followed through.

Herbert believes it is too soon to tell yet what the impact of divesting will be on the fund, but he anticipates that it won’t be negative, at least over the long run. The fund’s investment universe has expanded again over time: the number of companies that the fund’s South Africa-free policy precludes is only 50 instead of 160 ten years ago, he says.

And because no additional issues—including investing in affordable housing on a local level, the environment, and animal testing—have been taken to the regents since the South Africa issue, no other socially motivated restrictions have been placed on the fund’s 15-20 money managers. While Herbert takes an active interest in social issues, he isn’t unhappy with the current situation: "We’re concerned about trying to manage the portfolio in a way that we can provide for support for the institution in the future the same way as when the dollars were originally received," he says. "The minute we put restrictions on an investment program, we may compromise our ability to do that."

Waiting for others to initiate action on these issues, as the University of Michigan does, isn’t uncommon, says Proffitt, the analyst from the IRRC. And rarely is it a university fund that breaks new ground on social issues. They tend to be reactive instead of proactive, only taking a stance on others’ resolutions. University funds are having an impact, says Proffitt, who wishes these funds would take their influence one step further: "They usually don’t come up with their own resolutions. That’s the ceiling. That’s where they stop."


From Investment Management Weekly
April 1991