Investors and the Environment

1. Investors and the Environment Lloyd Kurtz Principal Nelson Capital Management Environmental Sustainability in Business & Law Conference UC Davis School of Law February 12, 2008

2. Topics • Background • Can Environmental Investing Work? (An Academic Review) • Recent Performance, Prospects for the Future

3. Background

4. 1980 1989 – DSI 400 1971 Social Investing Has a Long History 19th Century: Religious investors avoid investing in alcohol, tobacco, gambling, weapons manufacturing, and other objectionable activities 1980s: Religious investors join forces with the Nuclear Freeze Movement and church groups in South Africa 1971: Pax World Fund founded, first socially screened mutual fund 1989: Launch of Domini Social Index, first broad-based social index

5. Money and Faith “In the New Testament, Jesus had more to say about money matters than any other single subject, be it worship, sexual behavior, violence and peace, or even eternal life...for those who would follow Jesus, economic questions are really spiritual questions.” - Burkholder (2002)

6. Socially Responsible Investing in the U.S. Socially Responsible Investing in the U.S. reached $2.3 trillion in 2005 Community Investing 1% $20 billion Screening + Shareholder Advocacy5% $117 billion Screening Only68% $1,568 billion ShareholderAdvocacy Only26%$586 billion Source: Social Investment Forum, SRI Trends Report 2005

7. Socially Screened U.S. Mutual Funds Source: Social Investment Forum

10. Can Environmental Investing Work?

11. Arguments Against • Hard, if not impossible, to implement. • Theory says: own everything. • Reduces the opportunity for outperformance. • Moves focus away from risk and return. Expect performance problems.

12. Theory Says: Own Everything In modern portfolio theory, the market portfolio (point P) offers the best combination of risk and return. This can be accessed via a low-cost index fund. The argument theorists make against social investing is the same one they make against active portfolio management.

13. Since 5/1/90 Domini Social Index +11.2% S&P 500 +10.7% Long-Term Performance Annualized Returns • Slightly Higher beta • Modest growth bias • Sector weights • Overweighted in Technology, Consumer • Underweighted in Energy, Utilities Domini Return Differences Likely Due To: Source: KLD Website, as of January 31, 2008.

14. Complex Attribution Studies • Equities • Kempf and Osthoff (2006) • 1992-2004 • Small Positive SRI effect • Geczy (2003) • 1963-2006 • No SRI Effect • Bauer, Koedijk, and Otten (2002) • 1963-2001 • No SRI Effect • Fixed Income • Derwall and Koedijk (2006) • No SRI Effect These studies all use the Carhart model, which accounts for style, market capitalization, and momentum effects.

15. Show them the chess slide

16. Arguments For • Environmental research is getting better. • Perhaps good environmental management is an indicator of good management. • Reduces the risk of earnings disappointments due to environmental problems. • Moves focus away from the near term to the long term. It’s worth a shot.

17. A Few Supportive Studies • Dowell, Hart, and Yeung (2000) • Found that companies with the highest stated environmental standards tended to be awarded higher valuations by the market. • Guenster, Derwall, Bauer, and Koedijk (2005) • Find that firms with high environmental ratings (Innovest) had superior earning power and stock performance. • Edelen (2004) • Showed that the investment universe of the Sierra Club Stock Fund outperformed the S&P 500 from Q1:2003 to Q3:2004.

18. How Urgent is the Problem? “Studies by the World Resource Institute and many others show that, with some regional exceptions, every life support system on the planet is in decline (i.e.: clean air, clean water, forests, topsoil, aquifers, fisheries, wetlands, biodiversity, etc.).” - Frank Dixon, 2004

19. Recent Performance

20. 3 Yrs Ended 1/31 Domini Social Index +5.5% S&P 500 +7.3% A Rough Three Years Annualized Returns • Slightly Higher beta • Modest growth bias • Sector weights • Overweighted in Technology, Consumer • Underweighted in Energy, Utilities Domini Return Differences Likely Due To: Source: KLD Website, as of January 31, 2008.

21. The Price of Oil Source: Bloomberg

24. Sierra Club Stock Fund Performance Source: Morningstar, Nelson Capital analysis

25. Winslow Green Growth Performance Source: Morningstar, Nelson Capital analysis

26. Generation Asset Management • “On course.” Source: “When principles aid performance”, Financial Times, April 30th, 2007

27. Further Information • Social/Environment Investment New Service • www.socialfunds.com • Annotated Bibliography of Academic Research • www.sristudies.org • JP Morgan Climate Change Investment Research • http://www.jpmorgan.com/pages/jpmorgan/investbk/solutions/research/climatechange

28. Notes • Bauer, Rob, Kees Koedijk, and Roger Otten. "International Evidence on Ethical Mutual Fund Performance and Investment Style." Working Paper, January 2002. • Derwall, Jeroen, and Kees Koedijk. "Socially Responsible Fixed-Income Funds." Working Paper, Erasmus University, May 2006. • Dowell, Glen, Stuart Hart, and Bernard Yeung. "Do Corporate Environmental Standards Create or Destroy Market Value?" Management Science, August 2000. • Edelen, Roger. "Benchmarking an Environmentally Responsible Investment (ERI) Portfolio." Sierra Club Funds presentation at SRI in the Rockies conference, October, 2004. • Geczy, Christopher C., Robert F. Stambaugh, and David Levin. "Investing in Socially Responsible Mutual Funds." Wharton School, Working Paper, May 2003. • Guenster, Nadja, Jeroen Derwall, Rob Bauer, and Kees Koedijk. "The Economic Value of Corporate Eco-Efficiency." Working Paper, Erasmus University, July 25, 2005. • Kempf, Alexander and Peer Osthoff. "The Effect of Socially Responsible Investing on Financial Performance." Working Paper, University of Cologne, Germany. June, 2006.