This article appeared on SocialFunds.com, January 28, 2006

How to Determine the Top 100
Sustainable Companies in the World 

by Bill Baue

Innovest Strategic Value Advisors and Corporate Knights announce the Global 100 Most Sustainable Companies at the World Economic Forum, documenting financial outpeformance.

SocialFunds.com -- The " Big Debate," an interactive dialogue amongst 600 attendees of this week's World Economic Forum (WEF) meeting in Davos, Switzerland on questions like the economic emergence of China and India, identified sustainability as the key issue requiring creative responses. One such response came today from Corporate Knights, a Canadian magazine on corporate social responsibility (CSR), and Innovest Strategic Value Advisors, a socially responsible investing (SRI) research firm, who announced the Global 100 Most Sustainable Companies in Davos.

Distinguishing this year's list from last year's inaugural compilation is the accompaniment of a study back testing a portfolio evenly weighted with this year's 100 companies over the past five years. The back test shows 7.11 percent outperformance compared to the MSCI World Index.

"Global companies' performance on ESG (environmental, social, and governance) issues is rapidly becoming more critical to their competitiveness, profitability, and share price," said Matthew Kiernan, chief executive of Innovest. "The Global 100 companies showcased here today have already demonstrated that sustainability premium, and we believe that they are positioned to reward their investors even more heavily in the future."

The first Global 100 list faced criticism last year in an AlterNet.org article by Paul Hawken, who helped introduce the notion of sustainability into the US in the early 1990s through such initiatives as the Natural Step. Focusing on some of the first companies on the list, Mr. Hawken cited a litany of unsustainable business practices of ABB (ticker: ABB) and Bristol Myers Squibb (BMY).

"Some of the companies I targeted then are on the list again," Mr. Hawken told SocialFunds.com.

ABB made the list again this year, but Bristol Myers Squibb joined the ranks of those dropped from the list. Also dropped were Pepsico (PEP--which Mr. Hawken also criticized last year), Shell (RD), Weyerhaeuser (WY), and Xerox (XRX). Companies added to the list this year include Coca-Cola (KO--which Mr. Hawken has criticized elsewhere), General Electric (GE), Johnson & Johnson (JNJ), and Nike (NKE). These changes have not altered the premise of Mr. Hawken's critique.

"My main point is that the criteria employed have little to do with sustainability as it is understood from a thermodynamic, biological point of view, that the term 'sustainable' is not defined by Corporate Knights or Innovest, and that the methodology is not transparent," Mr. Hawken says. "The list does not advance sustainability because it cannot define, measure, or recognize it."

The Global 100 website contains a page explaining the selection methodology, with a link to a longer document describing how Innovest identifies and measures corporate sustainability, as well as a link to the "frequently asked questions" page that further explains the rationale.

"Debates have been raging in various circles (e.g. academia, business, government, the UN, etc...) for a number of years over exactly how to define sustainability, and more importantly over what it should look like in practice," the faq states. "We do not have the pretence to know how to resolve this dispute, let alone be able to produce an authoritative blue-print for 'sustainable behavior.'"

"What we do know is that social, environmental and governance factors are increasingly relevant to financial performance, and that companies which show superior management of these issues are fast gaining an edge over their competitors--an edge which we believe will translate into outperformance in the long haul," it continues. "The Global 100 companies are therefore sustainable in the sense that they have displayed a better ability than most of their industry peers to identify and effectively manage material environmental, social, and governance factors impacting the up (opportunity) and down (risk) sides of their business."

Dr. Kiernan explained it more bluntly to SocialFunds.com recently.

"Are there imperfect companies in our universes?--Absolutely!" he said. "I personally have never run into a company that is perfect; if you're looking for perfection, you're going to have an extremely small--like, nonexistent--portfolio."

"So we're trying to avoid having perfection be the enemy of the good or the excellent," he continued. "What we are trying to do with all our products is to raise the saliency and the profile of sustainability issues as legitimate investment issues, and send that message both to other investors and to corporates."

This message has also made its way to academics. For example, researchers from Erasmus University in the Netherlands gave the Innovest methodology the stamp of approval by publishing a paper based on Innovest research in the peer-reviewed Financial Analyst Journal that won the 2005 Moskowitz Prize for SRI research.

Lloyd Kurtz, an SRI portfolio manager for Nelson Capital Management, founder of the Moskowitz Prize, and bibliographer of the SRIStudies.org website, places the issue of corporate sustainability ratings and arguments against them in a broader context.

"It's an ongoing philosophical battle between idealists and relativists, and most social investors are at some level idealists, so the people who implement their portfolio decisions have to be relativists--we have to look at the stocks and decide where we are going to draw the line, and right above the line will be a company that is a little better than a company that's right below the line," Mr. Kurtz told SocialFunds.com. "And wherever you draw the line, someone will criticize you for not being pure enough."