Sustainable Investment: Dow Jones Sustainability Indexes - Term Paper Example

Name: Course: College: Tutor: Date: SUTAINABLE INVESTMENT: CASE STUDY DOW JONES SUSTAINABILITY INDEXES INTRODUCTION Commodity Investments There are two major forms of commodity investments-direct and indirect- in direct commodity investment, investors purchase physical commodities that have money value such as oil, metal, agricultural produce or futures in derivative markets while in indirect investment, involve investment in equities; it is the more preferred mode of investment since the investor does not incur any transportation, storage and insurance costs as experienced in direct commodity investments (Agricultural Investment, 2011). On the other hand, direct commodity investments are risky since they depend on future contracts and yet the future is always uncertain (Investment Exchange Consulting, 2011); various factors determining future market prices can change and the resultant effect will be heavy loss. But given the nature of the business markets in the rapidly globalizing world, an investor has to go an extra mile so as to be better than the competitors therefore diversification on investments is advisable so as to manage risks, after all indirect investments are not 100% safe but just safer than the direct commodity investments because of their high liquidity and hence easier sellability within shorter and certain periods of time. An alternative to the direct commodity investments can be investing in mutual funds; this is an indirect investment method that operates on future contracts just like in direct commodity investment. The method has been observed to be more flexible and less risky as compared to direct commodity investments; it is advisable that new investors interested in long-term investments start with investments such as mutual funds before they get to purchase real commodities. To better understand the risks and returns involved in commodity investments, it will be important to understand commodity indices and their roles in ensuring investors understand what the whole game of investment is all about. In short, commodity indices are meant to show the investors a picture of what happens when for instance a company holds the top position on the indices ranking charts, in terms of returns and risks (AIA Research Report, 2007-2009). Examples of commodity indices include Dow Jones indexes, Bache Commodity Index, KLD DOMINI 400 Indices, FTSE4 GOOD index and many others. Of recent, investors are taking particular interest in commodity indices that deal with companies that engage in corporate responsibility programs; those that ensure sustainability and that are conscious of the purchasing communities. This study will focus on the relative performance of three sustainable commodity investment indices namely Dow Jones Sustainability Indexes (DJSI), Calvert Social Index (CSI) and the Australian SAM Sustainability Index (AuSSI). The main aim of the research will be to prove whether or not sustainable commodity indices are good, bad or marginalized investments, based on performances of the three case study investments; this will be through analyzing monthly returns from each of the case studies (DJSI and AuSSI) and comparing to the benchmark investment-CSI WHY the Investment is defined as Sustainable DJSI is termed sustainable because, it ranks sustainable companies based on industry-based sustainability and corporate sustainability performances (Dow Jones Sustainability World IndexSM, 2010). DSJI also provides investors and asset managers with standards on which to check their sustainable portfolios. On the other hand, AuSSI is defined as a sustainable index because it provides straight forward and focused standards of reference for Australian sustainability leadership and also encourages development and integration of ESG into the companies’ activities (SAM, 2005). CSI focuses on investments with companies committed to solving some of the big environmental and sustainable challenges such as water and energy projects-there is the Calvert global alternative energy fund and the Calvert Global water fund. It is also involved investments that have and maintain ESG principles (Calvert Investments, 2011) ESG Factors Relevant to the Sustainable Investment DJSI bases its investment metrics on Environmental, Social and Governance (ESG) such that the more a company adheres to ESG principles the better it is in terns of rankings. DJSI goes a mile further to eliminate companies that are not conscious towards ESG actors in their investments; for instance it may strike off companies dealing with tobacco from its lists and replace with companies that have a more integrated approach on ESG (Alderton, 2006-2010). AuSSI on the other hand bases its choice of sustainable leaders on economic, environmental and social developments, whereby the companies’ that meet the assessment criteria and are top in each industry category are chosen for the leaders sustainability index. At CSI, ESG actors are monitored or instance in governance, companies are checked or transparency in policy and procedures and generally invest in companies with good governance structures. The same happens in environment and social matters where companies are screened for; environmental performance above average and in social matters such as human rights and human relations. .LITERATURE REVIEW General Overview of Sustainable Investments In the past, investors considered investing in ethically principled companies; this is also the case in the contemporary world. But with new challenges posed by the rapidly globalizing world, there have been many topics of discussion that require sustainable approaches to manage the problems there-in, there has been need for investors to invest in companies that are sustainability conscious and those that generally engage in sustainable projects and programs as a means of giving back to the community. Issues such as climatic and environmental changes have been of interest to virtually all stakeholders, among other issues such as food insecurity and un-sustainability of energy sources hence the need for sustainable efforts that will ensure the challenges mentioned will be reversed to their original states or will be prevented from deteriorating further hence the commonness of phrases such as “going green” and “more sustainable”. Many investors have been putting their funds and assets into companies that will for instance help in curbing emission of green house gases (Kropp, 2011), help in starting projects that will ensure increased use of sustainable energy sources in the community or those that evidently cut down use of non-sustainable energy, those that are focused on ecological protection, protecting human and animal rights, and avoiding engaging in activities that pollute the environment such as smoking, use of weapons and dirty money making businesses such as gambling and corruption among other vices. The stringent criteria by investors has been a trend growing increasingly in the recent due to increased knowledge among consumers on the need of business relations to be mutual- that is give and give and not traditional give and take relationships. Also investors choose socially responsible companies because they are more often successful than socially-unconscious companies hence investors’ hope that as the company grows and increases returns, so will their invested money grow and they will earn good profits (Rafalaf, 2003) . Again less people are likely to purchase stock associated with companies doing bad activities hence the returns will always be poor (Bluejay, 1998-2011). For instance at Australian Super (AS), which is a share sustainable investment, ESG factors are the ultimate determinant of whether or not a company qualifies to be placed on the AS charts. Three steps of assessment are followed whence if a company fails at one stage of assessment it is disqualified. First, companies thought to be sustainable are randomly selected by AS, then by aid of private stakeholders, the companies’ sustainability status are ascertained and the unsustainable companies are excluded further scrutiny of the companies is done by ESG lens whereby the companies are checked on how far they adhere to for instance environmental policies by checking on pollution, gas and chemical emissions as well as waste management. The companies are also checked or social responsibility- how much they give to the community and how they behave like in minimizing energy use and so on. Corporate ethics and governance systems are also checked such as how fair and equal is the working environment. Secondly, the top performers are shifted; those companies that do well financially and in ESG and Thirdly the investment portfolios of the companies’ are considered to select the best all-round companies-which are then ranked based on performances, commonly referred to as “sustainability leader companies” (Australian Super, 2010). This is the general trend followed by most investment indices such as DJSI, AuSSI and CSI; the bottom line assessment is based on ESG factors. To have a clear picture, the next section will focus on the cases of DJSI, AuSSI and CSI. The case of Dow Jones Sustainability Indexes (DJSI) DJSI has been in place since 1999 and is one of the most studied commodity indices (AIA Research Report, 2007-2009; Alderton, 2006-2010). DJSI ranks companies based companies on their sustainability practices; those companies that set industry-wide best practices with regard to sustainability” (SAM Indexes, 2010). The sustainability practices are checked under two broad categories corporate sustainability, which is quantified financially and industry-based sustainability which is based on both financial and general performance through sustainability portfolios that show the return/risk picture. DJSI ensures global, flexible, consistent, reliable and standardizing services, whereby investment managers are assisted to draw their directions in investments. DJSI has about 8 indices in place currently, namely:- DJSI Europe, DJSI Euro Zone, DJSI Japan, DJSI Korea, DJSI worldwide, DJSI US, DJSI North America, and DJSI Asia Pacific. All the indexes operate under the standards of picking the first 20% of leading companies in sustainability in the named region or in the world depending on the index in question. DJSI has a strict assessment criteria-similar to that of Australian Super described in earlier section above- which seeks to “provide a bridge between companies implementing sustainability principles and investors wishing to profit from their superior performance and favorable risk/return profiles” (SAM Indexes, 2010). The criteria has growingly become stricter by the years with the most update of the criteria reported in 2010 (Dow Jones Indexes, and SAM, 2010a); this saw some companies out of the indexes lists and other in. An investment concentrating on both active and passive funds and certificates has been expanding its markets by introducing newer products such as the equity indexes licensed most recently in 2010 (Dow Jones Indexes and SAM, 2010b). In all the indexes performance calculations are done in dollars and Euros. Australian SAM Sustainability Index (AuSSI) AuSSI was launched in 2005 and is one of the top performing investment indexes. It concentrates its effort on Australia based industries, at the moment analyzes the performance of about 21 companies hence giving the public an overview of the top sustainability leaders. Assessment and placement of companies by the index is purely ESG based using the corporate assessment criteria which is reviewed annually and hence allowing for healthy competition between the companies. SAM questionnaires, company documentations, observations and third party reviews are used as sources of information. Performance calculations are basically in Australian Dollars. Calvert Social Index (CSI) CSI was launched in 1982 and has since advocated for quality business management and practices-including ensuring companies give back to the communities and have the companies’ interests at heart. It offers the public an insight of the companies they have invested in by ranking a variety of funds, equities, bonds, assets investment indices. CSI has quality investment managers; it has been one of the widely accepted investment benchmark choices. It has been exhibiting high discipline and commitment in investment among other virtues such as high level of integrity. CSI has a high social profile given a record of initiatives especially in advocacy for human rights and safety; such as in 1982, the CSI fund was first to voice the cruelty of apartheid in South Africa and hence was one of the very first investment indices in a liberated South Africa. In 2004 the CSI und was on the forefront in advocating for women empowerment. In 2007, CSI fund went green investing in environmental projects specifically in alternative energy and also advocated for end of war and genocide in Darfur in Sudan. In 2008, the fund expanded its strategies by introducing three categories aimed at diversifying assessment of companies; Calvert signature, Calvert SAGE and Calvert Solutions. The next section on research methodology will provide an insight into performances-return/risks- at DJSI, and AuSSI. RESEARCH QUESTION/ Objective This study will research on the performance of DJSI and AuSSI -specifically those related to sustainability practices based on risk/return portfolios which will be subjected to in-depth analysis-as will be described below-so as to provide information and insight on the status of the investment indexes. The portfolios will be compared to alternative indices from the benchmarks-CSI-so as to establish how different the returns and risks are from those of other non-commodity investments/alternative indices. RESEARCH METHODOLOGY Data Collection Commodity index performance data will be used; annualized total returns, standard deviations, mean, skewness and kurtosis. Given that DSJI has 8 indexes, only one will be studied in this study-the Dow Jones Sustainability World indexes- so as to be able to give a well tracked and detailed analysis. Six years data is available and will be used by this study- 2005 to 2010. Monthly updates will preferably be used because it is more concise and tends to give details of occurrences at particular times; captures changes in financial performance unlike weekly and daily data that may not be representative of a certain season such as periods of inflation. Figure 1a: A graph representing performances (Monthly price and total returns) of the USD and EURO at DSJI World between 2005 and 2010 Figure 2a: A table showing averages and standard deviations of the returns by the US Dollar and Euro at DSJI World. Mean price return STD Deviation price returns Kurtosis Price Returns Skewness Price Returns Mean Total Returns STD Deviation Total Returns Kurtosis Total Returns Skewness Total Returns USD 969.9975 198.1834 -0.54934 -0.01227 1287.037 226.1088 -0.50356 0.01004 Euro 943.9076 164.464 -0.72293 -0.24139 1133.061 176.0411 -0.35411 -0.28064 Figure1b: A graph representing performances (Monthly price and total returns) of the AUD at AuSSI between 2005 and 2010 Figure 2b: A table showing averages and standard deviations of the returns at AuSSI (2005-2010) Mean price return STD Deviation price returns Kurtosis Price Returns Skewness Price Returns Mean Total Returns STD Deviation Total Returns Kurtosis Total Returns Skewness Total Returns AuD 1290.06 210.1964 -0.6596 0.1485 1472.24 244.0497 -0.9849 0.0208 From the figures above, 1a and 1b, it is evident that the performances at DJSI and AuSSI are closely related in that, from the plotted graphs, there is a similarity in trends especially between February and July, 2008-there is a great dip- this may be attributed to external changes probably in economic periods. For instance in Inflation, there are dips because each currency decreases in value; it can only purchase a few products and services than during normal times. The same case occurs in investment, during inflation periods less people are interested in investment, especially in long-term investments hence the dips as observed in the graphs. On the other hand, when financial times are good, and there is more money in circulation, many investors will want to put much of their fund into more long lasting investments probably saving for the rainy days in the future hence explained by the peaks in the curves. Figures 2a and 2b above shows details on skewness of the data (shows the symmetry of distribution of the values), that is how far left or right values lie away from the centre of a normally distributed curve. In this case, most of the skews are negative implying that most figures both on the Euro and USD performance curves lie on the right side of the graph and the likelihood is that there are more low values, with an exception of the positive skew of the total returns of USD and the AuD showing more high values lying on the left of the graph. Therefore the performances are more of normally distributed as better explained by the standard deviations which seem quite high therefore explaining that the returns at DJSI and AuSSI are so widespread away from the mean value. Kurtosis values are all negative in this case and denote that the values are distributed in a more flat manner than they would be if in a normal curve; in this case more values populate below the average. Research methods Returns and Risks will be calculated and these can be compared to returns/risks of equities to gain an insight on best investments-commodities or equities. Correlations between AuSSI and DJSI, and Calvert and other alternative assets so as to bring out a clear cut picture on the performances. Portfolio analyses will also be done so as to understand better the benefits of placing the commodities in the portfolios in question and alternative portfolios Risks/returns This are measured using standard deviation in terms of volatility returns. Standard deviation measures the total risk of individual assets and portfolios of assets. The coefficient of variation is normally used when comparing two assets on a risk-to-return basis. The coefficient of variation CV=si/ri Whereby si = the standard deviation of asset i and ri =the mean return of asset i In this case therefore, DJSI total returns Standard deviation References Agricultural Investment (2011). How to Invest in Alternative Asset Classes. Retrieved from www.sopreproc.org/how-to-invest-in-alternative-asset-classes.htm 5April, 2011 AIA Research Report (2007-2009). 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