March 1, 2002

CalPERS

Last week CalPERS announced its intention to remove Indonesia, Malaysia, Thailand and the Philippines from its investable list because the countries do not meet their new investment standards. This has brought SRI into the full glare of Asian Market Makers. The story has been prominent in investment commentary around the globe and triggered considerable debate in the region.

Share your thoughts at www.asria.org/forum

The Wilshire Report and CalPERS process CalPERS' permissible market analysis has been conducted by Wilshire Associates since 1987. This year the methodology has been improved and has defined two forms of risk: country risk and market risk. The market risk examines the ability of specific markets to support institutional investment while the country risk examines factors pertaining to a particular country. Wilshire examined eight separate issues awarding a score of between one and three on each issue to every country. It is important to note that the final evaluation was made on a balance of market and country factors. A poor score on one issue does not necessarily lead to exclusion. This year Wilshire expanded the country risk section to include transparency and productive labour practices. The examination of productive labour practices is a very welcome development. Verite (subcontracted by Wilshire) looked at a country's ratification and adherence to two ILO conventions covering labour rights and prohibitions on abusive labour practices. Based on Verite's analysis Wilshire then awarded points to each country. Totaling the eight scores for each country Wilshire thus compiled an "investable" list. The full report can be accessed at www.calpers.ca.gov. The investment policy is driven by the State Treasurer and CalPERS Board. They state that it is constantly evolving and the next Investment Meeting on March 18th should help to clarify some of the issues raised below.

The Verdict

CalPERS high profile decision to include SRI issues in the investment process is to be applauded. It is a significant advance in the principle that humanitarian factors can impact investment returns and are legitimate matters of concern for fund managers. It also highlights the ownership responsibilities which shareholders have, and the role of funds in fostering sustainable enterprise. This is a very necessary development for Asian markets.

However it is important to remember that SRI issues are not the only determinant for CalPERS in deciding where to invest. Transparency and Workplace Practices are only two of the eight factors that CalPERS have chosen to look at and decisions have been made on the totality of these eight considerations. Indeed more weight is still given to market factors. Turkey for example scored poorly on country factors but due to its strong market framework it is still included on the investable list. The Philippines scored highly on country factors but is excluded.

What is important is the manner in which CalPERS have chosen to implement these policies. They have raised key issues for the development of SRI in the region. We would highlight four particular issues.

1. Investability at a country not company level
2. Using a simplistic numerical scoring system
3. Following a negative exclusion rather than positive engagement approach
4. Workability and manner of implementation.

1. Taking a Country Stance

Irrespective of its position as a global shareholder, CalPERS has sent an important message to these governments regarding their ratification and respect for core ILO conventions. It is important that governments are challenged to support basic workplace rights and the CalPERS decision will undoubtedly help the reform process within government.

However the decision does little to support the reform process where governments, such as in Thailand, have been making significant progress since 1997.

Additionally, such a definitive statement may fuel anti western (American) sentiment in some of the moderate Islamic states of South East Asia. The decision may also reinforce the view that SRI is nothing more than the imposition of a western cultural agenda with little regard for the cultural and development realities of different countries.

2. Country vs Company

CalPERS decision to apply Productive Labour screens at the country rather than the company level is surprising. By excluding entire countries, companies that have good social and human rights records are not incentivised to continue their policies. Numerous companies who measure up to global best practice in SE Asia have effectively been 'black-listed'.

Tell us if you know companies which you think have been unfairly 'black-listed' in this way.

Equally there are many companies who fall significantly short of the standards which CalPERS promotes, within markets where CalPERS remains as an investor. By not engaging at the corporate level, as CalPERS does in the US market, the Fund is missing an opportunity to interact directly with management where they have the most leverage: as shareholders.

3. Numerical rating system

Can the use of aggregated scoring systems truly reflect reality? While extensive background research and engagement was obviously undertaken, reducing that to a ranking between one and three is problematic. Given the distinct and diverse challenges that confront individual countries attempting to apply uniform metrics can leave many unanswered questions. While it is always easy to judge with hindsight, the fact that Wilshire identifies Argentina as currently one of the most suitable emerging markets for investment highlights the potential flaws in numerical rating systems.

4. Negative exclusion vs positive engagement

SRI has the potential to be a key market mechanism for promoting sustainable economic development. The business and investment case for sustainable corporate practice is beginning to find support in Asia. As US shareholders have amply demonstrated in their home market, funds driven by a positive engagement philosophy, including the voting of shares, can significantly influence business towards more sustainable practices. CalPERS decision unfortunately seems to be sending a different message and through disengagement they run the risk of undermining the development process and fostering isolationism.

5. Evolution and Implementation

Over the coming months it will be important to clarify how CalPERS intends to implement these new guidelines and what scope there is for evolution.

Evolution: CalPERS have made it clear that this is an iterative and evolving process. It will be important to establish how CalPERS propose to monitor the situation. Will they adopt a passive approach relying on the yearly updates from Wilshire Associates, or will they also engage with corporations, governments and progressive reformers on the ground? As the example of Argentina illustrates circumstances can change very quickly. Given such fluidity, it will be important to determine whether CalPERS intend to monitor and reward progress.

Implementation: Implementing this investment policy raises other questions and certain matters require early clarification. Even though a country can be on the excluded list it appears that equities from that country can still be purchased in the markets of countries which are not excluded. To that end CalPERS has the facility to buy Chinese assets listed in Hong Kong (red chips) despite China being on the excluded list. Equally how will CalPERS treat multinationals who have substantial interests within excluded countries?

These are the key issues we have identified, what do you think? Are there other aspects of the CalPERS decision which concern you or deserve credit. To foster greater understanding we also want to hear your views. A Forum to gather feedback and encourage the debate is now up and running on our website at www.asria.org/forum. Come join us and add your views!