ETHICAL INDEX RAISES ISSUE OF SECTOR EXCLUSION

Constituents of new FTSE benchmark trigger debate

on problems facing socially responsible investment

1. FTSE is about announce, possibly as soon as next week, which companies are in its new ethical indices, FTSE4Good. It should make interesting reading.

2. The indices are primarily benchmarks for the ethical investment industry, but they will undoubtedly attract wider attention. FTSE, owned by the Finan­cial Times and the London Stock Exchange, has explic­itly said it wants to help stir up debate.

3. One of the knottiest prob­lems in creating this kind of index is whether you exclude whole industries such as arms or tobacco, or instead work on a company-by-company basis, picking the good ones regardless of their products.

4. If for instance tobacco maker BAT is included, some people will dismiss the exercise as a waste of time. The public perception of eth­ical is closely bound up with this negative approach.

5. The concept of ethical is steadily being replaced by the broader one of "socially responsible" investing. But the industry has a tradition of excluding sectors, reflecting its roots in invest­ing the money of church bodies and other ideologi­cally motivated groups. Many argue that while it is legitimate for fund manag­ers to exclude sectors, for an index provider it is not. Ken Rushton, director of the Institute of Business Ethics, says that in sectors which are operating legally, "for someone like FTSE to decree against them I think is quite wrong".

6. When Dow Jones created its Sustainability Indices two years ago it opted to exclude just the arms industry, and only then when arms repre­sented more than half of a company's revenues. While DJ also offers custom-built indices for clients who want to exclude other industries, Alexander Barkawi, the managing director, says that these represent only 15 per cent of the total.

7. When FTSE began consult­ing in February it had a long list of possible exclusions, including animal testing, nuclear power, pornography and companies engaging in "irresponsible marketing of breast milk substitutes". But it stressed it was open to cutting back this list.

8. Dr Craig MacKenzie of the FTSE4Good advisory panel says their consultation results were evenly divided, with about 20 groups strongly in favour of sector exclusions and 20 against. He adds that the committee "has been very sympathetic to the argument for looking at individual performance rather than using sector exclusions".

9. While FTSE has yet to announce its decision, Dr MacKenzie stresses there is a long-term aspiration to operate without sector exclu­sions. Once FTSE4Good has had a few years to build up a more sophisticated database, it will be easier to use a com­pany-by-company approach.

10. As for expelling companies once the indices are up and running, Dow Jones has not yet seen fit to do this, although it has downgraded two companies, Credit Suisse and Sulzer, as a warning shot. In the US the leading SRI index provider Domini recently dropped Wal-Mart from its Domini 400 index.

11. Whatever FTSE decides, there will be criticism. Simon McRae at Friends of the Earth is a strong believer in the need to exclude the likes of BAT, although he welcomes ethi­cal indices. But he rightfully points out that the real test of indi­ces is: "Can they demon­strate any real change?"

12. Rob Lake, head of SRI at Henderson Investors, says that FTSE's indices "will not be a perfect match" with what funds like his own do. He expects that they will set companies "not too challeng­ing a hurdle to cross", but says: "There are plenty of companies that won't even get to that level."

13. That is where it will get interesting.

Date: 2016-04-22; view: 650