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Can socially responsible investors raise the tide for all investors?

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Jennifer Sireklove, CFA, Managing Director of Investment Strategy

      Seattle - Spend any time talking about responsible investing, and quickly the conversation turns to whether it hurts or helps returns. The discussion always comes from the perspective of relative returns—that is, whether responsible investing can help an investor outperform a benchmark. What we never ask is perhaps a more interesting question: Could responsible investing improve the return of the benchmark itself?

      This question is especially relevant for so-called passive management—managers who are trying to be the market instead of beat the market. In a world that justifies responsible investing only on the basis of relative returns, there's not much room for such a manager. Which is a shame, given the potential benefits of improving the returns of broad indexes. But it doesn't have to be this way.

      To examine the topic further, let's draw a distinction between active investing management on the one hand and passive investing management on the other.

      Living in a world of relative returns

      Let's say an active investment manager identified an issue as being financially "material" to a public company. That is, he or she believes it will affect the company's revenues or costs and therefore its intrinsic value. But this is only the beginning of the game. If the manager's beliefs are in line with investor consensus and this issue is "priced" into the stock, there's nothing to do. It's only when the manager has identified what they believe to be an underpriced security that it's time to trade. And it's only when the bet proves out and the security increases in value more than the benchmark average that their efforts are justified.

      This is the active investment manager's path to success in the world of relative returns, whether they describe their approach to determining financial materiality as "responsible investing" or not. The payoff comes only from owning a portfolio that differs sufficiently from the benchmark and consistently contains stocks with above-average returns.

      The value of company engagement

      The situation is very different if a passive manager chooses to simply own everything and not worry about outperforming the benchmark. In this case a manager could take the same financial materiality analysis and use it not to decide whether to own a given stock but rather—through engagement with company management—to encourage the laggards to become better and the leaders to continue gaining ground.

      If successful, this could make any of the companies in the benchmark worth more than they would have been otherwise. But there's a catch: While it's easy to measure the value of differentiated stock picking—just compare the portfolio's return with that of the benchmark—how do we compare the value of a company whose behavior changed due to company engagement to the value of that same company without it? It would be purely hypothetical—a bit like asking someone to measure exactly how the world would be different had the Allies lost World War II.

      And yet just because we can't measure the value of engagement efforts precisely, does that mean it's not worth doing? Clearly, investors (and society) would be better off if shareholders could have prevented the mine break at Vale, the emissions cheating scandal at Volkswagen, the BP Deepwater Horizon disaster, or the Enron debacle. And this is true even if we can't measure exactly by how much.

      The bottom line:Company engagement can't make miracles happen. And it can't prevent all bad things. But investment managers (as shareholders) successfully pressuring public companies to address material risks could help increase overall market returns. This would reward both passive and active investors, who could continue to add excess return to an even higher base level. It may be hard to measure, but it seems like that must be worth something.

      Parametric is an SEC registered investment adviser and majority-owned subsidiary of Eaton Vance Corp.