Sunday, January 22, 2012

Are French better Stock Pickers ? A review of French SRI

Are the French worse at SRI, or are they better, and perhaps a bit more practical about measuring performance?

Many socially responsible funds advertise SRI as a way to increase returns on investment (ROI).  Even the United Nations, under the UN Principles for Responsible Investment have said that:
"There is a growing view among investment professionals that environmental, social and corporate governance (ESG) issues can positively affect investment portfolio performance."

Several American studies we have read seem to establish that SRI funds perform better than conventional indices, albeit ever slightly.   The most popular index, the KLD Social 400, is an index launched in 1990 to invest in U.S. based SRI type companies using both Negative and Positive Screening.  This index indeed has had a good long-term outperformance.  However, after reviewing several studies, we believe performance results are still not clear-cut.  Why?...well, we'll just touch on a few...
  1. Survivor basis:  Share price histories of  corporations that are bankrupt may not have been used in studies.  This upwardly skews performance.
  2. The "Chicken & Egg" effect:  It is not clear that companies with high ESG are that way because they can afford to do good, or that they did good first.
  3. Availability bias:  The majority of studies are conducted by students, and asset managers.  It is doubtful that they would publish studies that show weak SRI performance, as most authors are trying to "make a case" for SRI.
  4. There are few standardized definitions of ESG; studies tend to look at different factors.  For example, some studies focus on the outperformance of companies in the Fortune 100 Best Companies to Work for list.  However, many SRI analysts do not consider such companies as necessarily highly ranked in ESG. 
Could performance perceptions be cultural?
Further, there is a positive bias among those researchers (many of them American) that are conducting the studies.  However, such bias may be cultural.  According to a Novethic study entitled ESG Perceptions and Integration Practices, French do not believe that ESG will increase fund returns.  In fact none (0% of those surveyed) believed that SRI would improve performance.  The most popular survey answer, at 59%, was "Contributing to bringing about a more sustainable business model" with 30% looking to "Manage long-term risks."  In other words, French utilize SRI because it's the right thing to do, not because they expect to receive handsome rewards.  For comparison, a large 57% of surveyed asset managers in the United Kingdom believed SRI could improve performance.  (We are using the UK as a substitute for the United States, which was not included in the survey.)

Does French performance data support their beliefs?
We have reviewed three (related) French SRI studies on investment performance.  All three studies were conducted by the EDHEC-Risk Institute.  École des Hautes Études Commerciales du Nord (the long name) is one of the top business schools in France (est. 1906).  Our favored study is the report entitled French Corporate Social Responsibility: Which Dimension Pays more? (Published June 2010).

Its results stated that "At the aggregate level, i.e, when all events are considered simultaneously, it appears that CSR has a positive (0.05%) but not statistically significant impact on a company's stock returns."

The short answer to the headline question above, is that Yes, French performance data do support their belief that SRI does not increase performance.

But lifting the rock reveals some interesting findings...
So why do we like this study you ask?  Well, it gives us hope.  The purpose of this study was to separate the dimensions (factors) of CSR to examine which particular ones were relevant.  In other words, what would the results look like if we isolated the "C" for example, from CSR.  The study actually examines 6 different dimensions, and four of them yielded an average positive cumulative abnormal return that was statistically significant.

The best were Environment (the "E" in ESG) and what the report called Insertion, which is helping young and handicapped people in their careers (in other words, the "S" in ESG). Suburbs also performed well, which is related to helping local communities, and is also the "S" from ESG.  We note this correlates with the outperformance of SRI investments using the Fortune 100 Best Companies to Work for list, which is more related to the "S" than the other dimensions examined in the French study.  (Note: As a reminder, SRI refers to the act of investing in companies that utilize CSR/Corporate Social Responsibility and ESG/Environmental Social Governance.  SRI is from the investors' perspective, while the other two are from the corporation's view.)

Cumulative Abnormal Returns Comparisons (click to enlarge)
Source: EDHEC, June 2010

Two additional French studies
The other two studies (one is an update) were based on the original EDHEC paper written in 2008.  The first study used the Fama-French three-factor model for a six-year period ending in 2007.  The latest study's (September 2010) goal was to update the latter study to examine the effects of the Financial Crises on socially responsible investments.  This study examined 62 funds over a fairly long period for SRI (8 years).  The sample was split into two types of funds: Traditional SRI, which is mostly best-in-class funds and a Green group of funds.  Note that Negative funds that screen out for sin-stocks are not as popular in Europe as in the States, and thus, were not examined.  The Green group included funds that are related to the environment such as renewable energy, water preservation or climate change.

Did the Financial Crises affect Socially Responsible Investments?
The results of the September 2010 update (The Performance of SRI and Sustainable Development in France: An Update after the Financial Crises) were not what investors were hoping for.  None (zero) of the 62 funds of the sample produced both positive and statistically significant alpha.  In other words, after adjusting for risk and the security market line, SRI funds did not outperform conventional indices.   The study appears very comprehensive as it not only looks at the conventional Fama-French factors (which are similar to Beta) but also examines and compares the VaR (Volatility at Risk) for the funds.  It notes that SRI indices exhibit both higher standard deviation (volatility) and VaR than conventional indices.

Side-note on the studies' use of Green Funds.  Firstly, Green Funds should be examined with a long time period (perhaps 20 years if possible) since their look-back periods may be too short as these funds may be leveraged to energy prices and solar subsidies and such are cyclical in nature.  Secondly, we note that certain investments in Green Funds may not be considered socially responsible by SRI aficionados.

The study highlighted Green Funds, of which had better returns than traditional SRI funds with a slightly higher risk.  However, this is not what we have experienced in the United States.  Ethanol and Solar companies, for example, have had extremely volatile stock prices over the last 5 years, though we cannot provide our readers specific alphas at this time.

Lastly, the study analyzed the effects of the U.S. led Financial Crises onto SRI funds.  The general conclusion was that SRI funds were not spared the increase of extreme risks during the crises.

Our Conclusion:  It appears that the French are no better and no worse at socially responsible investing compared to the Americans.  However, the French culture, which includes their historically more intense reliance on statistics, produces a more realistic conclusion.  We are yet to be convinced that SRI improves investment performance given all the extra work and analysis involved (and higher volatilities).  This "extra work" results in higher management fees to investors (i.e., lower net returns). Future studies will no doubt answer this question one day...

Tuesday, January 17, 2012

Apple's Asian Experience: What's going on ?

On January 14th, 2011, S&P's European downgrade was the "shot heard round the world." And still, Apple's Asian experience managed to climb to the top of the Wall Street Journal's Business & Finance page.

Apple, Inc.

What's going on?  
Well, like Google, Apple's finding itself caught between the promises and perils of doing business in Asia.  Apple had to temporarily halt sales of its new iPhone after a disturbing wrangling outside its flagship store in Beijing.  Migrant workers hired by "scalpers" started pelting the stores with eggs and getting unruly after the company sold out of phones.  (While Google has to deal with Chinese censorship, Apple has its own Chinese problem - the authorities forced it to disable iPhone's Wi-Fi capabilities.)

Supplier Working Conditions Report:
The other news of the day, was the release of Apple's Supplier Responsibility Report) after a tad of nudging by activists. The urgency to release the report grew after employees at its Foxconn supplier threatened mass-suicide if working conditions hadn't improved.

As an American, I think it's difficult for us to understand just how inhumane these conditions are.  We think in general terms (e.g., "Sweatshops") and how some factories hire under-aged workers. But these kids aren't working 10 minutes for ice-cream.  In reality, it's closer to legalized slavery.

It is in Apple's best interest to put its "best foot forward" by pointing towards progress at its suppliers.  And they do.  However, after going to the source and reading the Supplier Conditions report, I tell you it's DISTURBING.  It's considered a GOOD thing if the average worker spends less than 60 hours a week working (and rec 1 day of rest after 7 days).  Apple identified 110 facilities where this has been a continuing problem.

Source: Apple Inc., WSJ

Workers must also deal with combustible materials, which last year resulted in explosions at Foxconn (making headline news).  Though, overall, the area with the lowest ratings was management information systems.  This may not sound important, however, these systems allow suppliers to execute corrective actions and hold managers accountable.

source: Apple Computer

At what cost is ESG Compliance?
I researched the costs involved with making a company fully "ESG compliant" - from "cradle-to-grave."  It turns out, there is no comprehensive data on the subject.  However, it's my sense that there is a more than negligible cost.  Maybe the question really should be, "Is there a Financial Reward for ESG investments?"

Who receives benefits from ESG Compliance?
Apple's suppliers clearly pay a cost for ESG compliance.  In fact, suppliers that were using indentured labor have already paid nearly $7m to employees after Apple's audits (Source).  Apple also pays for ESG compliance as the company reports (and reduces) its yearly Carbon Footprint from the design to the recycling stage.  However, it is Apple that receives the benefits because it is its name on the product and due to its strong market position.

Apple's market position allows it to reap from ESG efforts.
Using Porter's 5 forces framework of Industry Structure, one can easily see that Apple is in a venerable position as it has huge Bargaining power against its Suppliers, and its sometimes cultish customers (there is only one iPhone).  And despite Android, the threat to its ecosystem is minimal given its closed nature.  According to several white papers, ESG-centric companies receive several benefits including higher valuations, better profit margins (see graph below) and lower costs of capital.  This is because they're less subject to accounting issues and litigation, and tend to have more capable management.  See link for additional information.


Apple's Steve Jobs has been known for being stingy with philanthropy and the company historically has been somewhat of a laggard as a Green Citizen (Source:  But it's not known whether Jobs may have given anonymously or left these decisions to his wife/estate.  What is apparent is that the new CEO Tim Cook (previous COO) knows factories.

Now that Jobs' powerful personality is gone, Cook will be able to provide a more nurturing face to the world. The Supplier report was a good step in this direction given that Chinese authorities would rather keep such disclosures out of the public eye!

Disclosure: the author is long AAPL, and wrote this article on a Macbook!

Editor's Note: just to be fair, the supplier issues are an industry-wide problem, and not just an issue between AAPL and Foxconn, etc.

Friday, January 6, 2012

Nike: At what price is Social Responsibility?

I remember way back when Nike just made running shoes...their classic waffle-inspired ones.  Now the company produces shoes for all kinds of activities and apparel revenues alone approximate $5Bn!  Nike's revenues were $20.9Bn in FY 2011.

Historical earnings and revenue growth, and the overall management of the company, has been quite admirable.  Founders Bowerman (deceased) and Knight (a 4:10 miler) left the company in good shape.  One of the last, but most powerful accomplishments Knight left the company with was its leading position in Corporate Social Responsibility ("CSR").

CSR Efforts did not come naturally to Nike...
CSR did not come easy for Nike.  For years, the company was criticized by Human Rights Groups for using sweatshops.  The company has been subject to much critical coverage of the often poor working conditions and exploitation of cheap overseas labor employed in the free trade zones where their goods are typically manufactured (link). Sources for this criticism include Naomi Klein's book No Logo and Michael Moore documentaries.  As of 2011, Nike has made great strides in monitoring most of its factories so that workers are not abused in any way.

But there's still work to be done...
On Dec'11, Nike released its latest iteration of the (Michael) Jordan sneaker.  Retailing at $180, this shoe has an iPhone cult following bringing the company about $1Bn in revenues.  However, we're not talking about "Bobos" and "Yuppies" buying these shoes.  Instead, its lower-income earners (mostly guys living paycheck to paycheck) that Nike's marketing to. In fact, shoe launches are usually 
timed perfectly to the exact day customers receive their paychecks. (Source story: WSJ). Surely, this should give socially responsible investors pause.  It just ain't right, It ain't Right!

AP Photo/Marcio Jose Sanchez
So what's Nike worth?
Presently, Nike's shares are overvalued, or are they?  Nike's shares are either fairly, or overvalued using several metrics including Prices/Earnings and Discounted Cash Flow.  According to a Fidelity StarMine report, Nike's P/E (trailing 12mos) is 20.8x versus 14.2x for the shoe/apparel industry.  Over the last 5 years, Nike's median P/E was 16.7x, with a peak of 19.0x, according to Stifel Nicolaus (whom uses forwards estimates).

According to Jefferies research (which provides forward earnings estimates on each member of the peer group) Nike has the highest P/E ratio (See below).

What's Nike worth using Free Cash Flows?
I calculated the intrinsic value of Nike's shares using a 3-Stage DCF model.  Short-term growth (< 5years) was estimated at 16% and attributed to the strong orders book and several upcoming events (e.g., Summer Olympics, World Cup).  I discounted cash flow at a weighted average cost of capital of 10%.  The somewhat lower number (than we usually use) was attributed to the company's CSR efforts, high credit rating (Moody's: A2), low share beta (GoogleFinance beta: 0.9) and consistent earnings.  Our Calculated value of $93 is actually below the current share price of $97.

<click to enlarge>
Source: Socially Responsible Investing
So then, what's the extra-value of CSR worth?
Clearly, Nike's shares are worth more than others.  Using the data sources cited above, it's shares trade at a premium between 10% and 45%.  We can assume that its CSR efforts awards it a higher value.  Its higher valuation is also attributed to a:
  • Strong global brand name
  • Innovative products
  • Consistent earnings growth and value creation
  • Strong financial metrics 
In this link readers will be able to read Moskowitz Prize winning articles including the most recent, which notes that costs of capital are lower for companies utilizing CSR efforts. The Moskowitz Prize is awarded every year to those researchers that have done "outstanding work in Social Responsible Investing."
      Nike is clearly a track-star and its above-average valuation shows it.  I believe the higher valuation is partially attributed to its leadership in CSR as well as the company's strong track record of earnings growth.  2011 was a tough year for the company given higher raw material costs that cut into gross profit margins (SA article), but global commodity costs have already started declining sharply.  On the demand side, 2012-13 will show improvements given an upcoming product cycle (e.g, NFL deal) and the 2012 London Summer Olympics.

      The only threat to Nike's improving outlook is that we're expecting a Euro-Crises during 1H'12.  This could slow EU demand given that over 20% of revenues are from the area (incl Eastern Europe).

      Disclosure:  The author's long NKE and enjoys taking long jogs with a pair of his favorite Nike Free Runs.

      Tuesday, January 3, 2012

      SRI comments on CR Mag's Top 100 Corporate Citizens

      During March '11, Corporate Responsibility Magazine released its now 12th annual list of the 100 Best Corporate Citizens list.  Please click here-->>100Best pdf.

      On the bottom of this article we've provided a snapshot of the list (the top 15) courtesy of CR Magazine.  Below, we make a few comments on this newer list given our familiarity with its history.

      The most significant observations are below:
      • The process to get onto the list have become more transparent.  This is very important for a magazine that is seeking the same from corporations.  In fact, in years past CR Magazine had been criticized for being a bunch of hypocrites as their Corporate Citizens methodology had not been clear.  I examined both their overall methodology and broad categories (see below) as well as the minutia within these categories.  Essentially, I like what I see for several reasons.  For example, the questions are asked in a way that is not "framed" and the required answers are clear and objective, like True or False.  Such surveying will be useful going forward for historical analysis.
      •  Note well that each broad category has a weighting.  We recommend users focus on the categories that are most useful.  This website, for example, will de-emphasize the "Financial" weighting as it will be conducting independent  financial analysis, which requires significantly more detail and transparency than a simple score that is provided on the list.  SRI website would like to see a higher percentage for Governance than the 7% that's assigned.
      •  Listed companies that have acted "naughty" are now given "yellow cards", or "red cards" if they were really bad.  Yellow card companies remain on the list, while red carded ones are excluded from the list for a 3YR period.  (Red carded cos excluded from the 2011 list were: Allergan, Exxon Mobil and Pfizer.)  I am glad this carding has been initiated because most of the companies on the list are large & complex.  Companies, like people, always have "dirt in their closet" depending on how hard you dig.  The carding process allows a first screen, if not, at least an awareness of the above fact.
      • Unfortunately, small companies are now excluded from the list.  CR 2007 list, for example, included non-blues such as: Green Mountain Coffee Roasters,, Interface, Lam Research, Gaiam Inc., Wainwright Bank & Trust, Chittenden, Energy Conversion Devices, Ormat Tech, WGL Holdings, Bright Horizons, Baldor, Advent Software, Coldwater Creek, etc.  One concern we've had lately, has been the fact that most Blue Chips seem to be on these lists.  Just think, if they're 100 cos on the list, then 20% of the S&P 500 are included.  We also don't like the fact that ESG has become another cost-center for large companies.  This gives them ESG bragging rights (and aids in marketing efforts) and seems to lack authenticity.  But, yes, it's true that it is better to have such companies than none at all.
      • We manually cross-referenced CR Magazine's lists with others.  Here's what we found.  Several of the CR Top 100 were ranked highly by CSRHub.  This is a website that aggregates ratings from several ESG data contributors.  We screened for CSRHub's highest rated US-based companies.  These companies typically are rated between 59 and 68, and are thus ranked in the top 5% of the US database.  This compares to the average of 48 in the database.  We then checked this list against CR Magazine's list.  We found a total of 36 of CSRHub top 5% ranked companies on CR Magazine's list.  Half were in the Top 50. 
        • Highest ranked companies were within the Technology industry, with the highest rating honor going to Hewlett Packard (a whopping 68 rating!).
        • Other companies with high CSRHub ratings that were also on the (Top 15) list were:
          • Johnson Controls (64 CSRHub rating)
          • IBM (67, and 2nd highest ranked, and tied w/ Intel Corp.)
          • Bristol-Myers Squibb (59)
          • 3M Corp (60)
          • Kimberly-Clarke (60)
          • Nike (61)
          • Gap (62)
          • General Mills (60)
          • Intel (67) and 2nd highest ranked
          • Coca-Cola (60)
          • Pinnacle West (62)
      • In addition, the CR List was cross-checked with Boston College's ("BC") "Most Socially Responsible Companies in the U.S. in 2010."  This list comprises 50 companies, and has a high proportion of companies within the Technology industry.  Hmm, maybe that industry (especially Software cos) have an unfair advantage, No?   We found a total of 22 of BC's Top 50 in the CR Top 100 list.  A large number (17) of them were in the CR's highest 50 ranked.  See below for the Top 15 cross-reference with the BC list:
          • Campbell Soup (ranked 16th by BC)
          • 3M Corp (50)
          • Hewlett-Packard (48)
          • General Mills (22)
          • Intel(12)
          • Coca-Cola (36)
          • Avon (28)
          •  * Avon's 16th rated on the CR list (hence not on the table below)
      •  But what would the Working Mothers ("WM") of the U.S. say about CR's Corporate Citizens list ?  Well, we also cross-referenced against WM's lists.  We examined WM's list of Best Green Companies for America's Children, Best Companies for Hourly Workers and their popular 100 Best Companies.  For the 100 list, the Top 10 were checked WM does not rank the companies other than providing a Top 10 list.  Below are the names that appeared both on the CR list and Working Mothers' lists:
          • Campbell Soup
          • General Mills
          • Intel Corp
          • Johnson &  Johnson
          • Starbucks
          • Clorox
      • Last, but not least, we checked CR's list against the Companies that Care Honor Roll (2009, 2010).  This list tends to have small, private and lesser known companies so it rarely makes other ESG lists.  Some of the companies we recognized as being on other CR lists from the last 3 years:
          • Baxter International
          • CB Richard Ellis
          • Interface Inc.
      Well, that all folks!  We, at the SRI website, hope these rankings help investors and other stakeholders in their initial screenings.  It helped us, as Interface Inc. was extensively written upon on this site after noting it was on a past CR list.

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