Goldman Sachs Adds Own Twist to Social and Environmental Assessment

Socially responsible investing (SRI) is showing signs of being memetic -- in other words, spreading like a cultural virus.

NEW YORK — Socially responsible investing (SRI) is showing signs of being memetic -- in other words, spreading like a cultural virus. Specifically, traditional "mainstream" investors are starting to integrate social and environmental considerations into fundamental analysis of companies. Take, for example, Goldman Sachs (GS), self-described as "one of the oldest and largest investment banking firms," which recently issued a report to its clients entitled Global Energy: Sustainable Investing in the Energy Sector. Judging from this report, SRI strategies seem to be catching.

GS inaugurated its own assessment of issues typically associated with SRI with its February 2004 launch of the Goldman Sachs Energy Environment and Social (GSEES) Index, assessing 30 social and environmental criteria in the global energy sector. It subsequently expanded coverage with its Environment, Social and Governance (ESG) Index, increasing the number of criteria to 42 while adding a corporate governance category.

"We believe that this template will be applicable across most industries because it captures the full spectrum of a company's interaction with the four key pillars: the economy; the industry in which it operates; society, from employees to partners, consumers, and counterparties; and the environment, in terms of resources consumed, emitted, and produced," state GS Analysts Anthony Ling, Sarah Forrest, Andrew Baird, and Matthew Lanstone in the report. "We believe excellence is a habit and that companies with superior environmental and social management are likely to be more successful in operating projects in the new world."

The tome-like 164-page report demonstrates how GS applies its sustainable investing strategies to the global energy sector. The report finds GSEES leaders financially outperforming their peers by 12% since the index launch. It also finds strong financial performance by energy companies exposed to so-called "new legacy assets" -- the largest oil and gas fields as defined by reserves that will drive the future of the industry over the next 20 years. Significantly, the report finds a strong correlation between strong ESG performance, exposure to new legacy assets (GS identified the top 50 such projects in June 2003 and the top 100 in January 2005), and financial performance.

"Companies that screened as both GSEES leaders and Top 50 winners have outperformed their peers by 24% on average since February 2004," the report states. "Laggards on both measures have underperformed by an average of 5%."

Assessing the convergence of ESG performance, exposure to new legacy assets, and financial performance, the GS report identifies six leading companies: BG, BP (BP), ExxonMobil, Petrobras, Statoil, and TOTAL. Up-and-coming companies with "potential for improvement on a sustainability investing basis" include BHP Billiton, Chevron, ConocoPhillips, and Marathon. Companies that have shown "disappointing performance compared with their peers on either absolute ESG scores or Top 100 performance, or on their momentum over the last two years" include Amerada Hess, ENI, Occidental, and Shell.

Obviously, what distinguishes GS's methodology in this report from typical SRI approaches is the additional consideration of exposure to new legacy assets, while the ESG Index covers similar if not identical territory to most SRI research. The ESG Index ranks companies (based on information from their own disclosures) in five categories: environment, environmental and social management, social, corporate governance, and investment for the future. Interestingly, new legacy assets are not completely divorced from but rather intersect with ESG considerations.

For example, the investment for the future category assesses community investment.

"Investment in local communities is more important for the industry than it was ten years ago as companies develop reserves in politically riskier countries," states the report. "We have categorized around 50% of the industry's new legacy assets in very high risk countries, where company investment in education and health is a key part of the stability of the local economy."

GS's Top 100 Projects, which assesses exposure to new legacy assets, factors in political risk (as measured by the Transparency International Corruption Perceptions Index) in the countries where new reserves are located.

"As production in mature fields has declined to be replaced by the newer, high-risk barrels, so the risk profile of the industry's production looks set to return to levels not seen since the mid 1970s," the energy report states. "Over 90% of companies in our coverage universe look set to see an increase in the country risk of their production."

Corruption assessment circles back to the ESG Index, which addresses it in the social category.

"Companies in the industry have moved to eliminate corruption through their codes of business conduct, reporting corruption incidents among employees, membership of EITI [the Extractive Industries Transparency Initiative spearheaded by British Prime Minister Tony Blair], and disclosing tax payments to individual governments," states the report. "We view this as crucial to their long-run success and competitiveness."

The spreading of cultural viruses can affect not only recipients but also transmitters, as notions and ideas mutate as they proliferate. Just as the traditional investment community stands to gain from incorporating social and environmental considerations into their analyses, so too does the SRI community stand to gain by observing how the fundamental analyst community innovates as it integrates SRI.