Elroy Dimson: A Framework for Responsible Investing

What is responsible investing?

Asset owners, investment managers and others ascribe different meanings to the term "responsible investment." For some it refers to socially responsible investment, others think of adopting a longterm investment horizon, while a further group is primarily concerned with environmental, social and governance (ESG) issues.

This paper is based on extensive research on responsible investing conducted by myself and fellow members of the Strategy Council for the Norwegian Government Pension Fund Global. The GPFG -- formerly known as the Petroleum Fund -- received its first capital inflow as recently as 1996; it is described in Chambers, Dimson and Ilmanen (2012).By April 2014 it had a value of NOK 5.1 trillion (U.S. $860 billion), making it the world's largest sovereign wealth fund.

Our study analyses evidence on responsible ownership strategies, and goes on to provide a framework for effective implementation of an integrated approach to responsible investment. More details may be found in the Strategy Council's report: Dimson, Kreutzer, Lake, Sjo, and Starks (2013). The figure below shows our framework schematically:

Motivation: why do investors invest responsibly?

Investors are often vague in their statements about responsible investing, making it hard to determine their ultimate motivation. Analysis yields five identifiable -- sometimes overlapping -- reasons why investors chose to invest responsibly. They may wish to:

1. Avoid unethical products

There are certain products with which investors do not wish to be associated, regardless of possible financial returns. The most common are arms and weapons, tobacco and pornography.

2. Avoid firms with unethical conduct

Similarly, investors may not wish to be associated with firms that are perceived as having breached certain ethical or moral standards, such as contributing to environmental degradation, showing a lack of respect for human rights, or a lack of fairness in business relationships or in dealings with society at large.

3. Be responsive to interest groups

Investors may be responding to core constituencies' environmental or social concerns, even if they themselves do not share these concerns. They are therefore responding in order to secure their "licence to operate."

4. Ensure the benefits of universal ownership

Very large funds with globally diversified portfolios typically own a stake in thousands of companies, providing cost- and risk-effective exposure to worldwide economic value creation. Such funds may fear that undesirable behaviour by one investee company will affect other investee companies. For example, some companies might benefit by externalising environmental costs through pollution, but this could raise costs for others, resulting in an economic loss across the portfolio as a whole. In such circumstances it is rational for investors to use their leverage to try to influence the behaviour of renegade firms.

5. Enhance performance through sustainability

By applying ESG or longer-term thinking to the investment process, investors hope to make better investment decisions, avoiding risks and identifying opportunities.

Developing clarity around the motivation for responsible investing is a critical first step for funds.

What research is there to support responsible investment?

Many funds employ responsible investment practices largely for economic reasons (the fifth point above). They believe that stock price performance, and consequently portfolio returns, are affected by factors that are not reflected in traditional financial metrics. Unfortunately, academic research to back this up is limited. Benabou and Tirole (2010) have argued that firms choose to behave more responsibly because: (i) taking a more holistic and long-term view will ultimately strengthen their market position, and thus increase value; (ii) shareholders choose to delegate their own social responsibility to firms as a matter of economic efficiency (again, creating value); and (iii) management may wish to enhance their own philanthropy. In the latter case, socially responsible behaviour is more likely to reduce a firm's value. Baron (2008) suggests that a firm's socially responsible activities may increase productivity, as employees will work harder or better for more responsible firms. A related, but different, theory is proffered by Besley and Ghatak (2007), who argue that more responsible firms will earn higher profits as a reputational premium to support good behaviour. Eccles, Ioannis, and Serafeim (2012) present evidence that companies that were early adopters of sustainability policies outperformed a matched sample. An analysis by Eccles, Krzus, and Serafeim (2011) concluded that investors appear more interested in the 'E' (environment) and 'G' (governance) than the 'S' (social) in the Bloomberg ESG platform. They argue that this is because, relative to social data, environmental implications are easier to quantify in valuation models and there is strong evidence of a positive correlation between firm value and improved governance.

Research does not provide conclusive answers. This makes it essential that firms elaborate a meaningful investment mandate, laying out specific goals that link motivation to investment principles and, in turn, ownership strategies.

Investment principles

One option in this area is to adopt any of the existing sets of responsible investment principles, such as the UN-supported Principles for Responsible Investment, or a national alternative. In the case of bigger funds, such as GPFG, it may be appropriate to exceed the demands of such generic sets of indicators.

Principles should detail how and when to apply different investment strategies, including criteria for divestment and exclusion. They should also identify how the effect of various strategies will be measured and reported, and note whether investment strategies are likely to have a material effect on portfolio risk and performance. It is at this point that any potential conflicts or compromises should be laid bare.

Ownership strategies

Principles are made operational through a variety of ownership strategies:

Portfolio monitoring

Many funds regularly screen their entire portfolio to identify companies that are potentially in breach of the UN Global Compact or the funds' own guidelines. They then choose engagement or divestment.


Funds are increasingly exercising ownership rights, even when they hold only marginal stakes in companies. Some funds assign proxy-voting services to cover holdings in large portfolios. The challenge for most funds is to ensure that their own voting policies -- which should be a product of their responsible investment principles -- are incorporated into voting decisions. Good practice calls for clear voting guidelines, incorporation of previous voting analysis, dialogue with the company in advance of 'against' votes, and follow-up communication in controversial situations. Some funds or managers have established guidelines for shareholder meeting participation and company communication.


Most funds engage with companies, though the purpose, form and desired result of engagement can vary widely. Engagement may stem from concerns about the company's financial performance, strategic plans or ESG behaviour and may range from simply writing a letter to calling managementand board-level meetings. Large funds, such as GPFG, typically have greater leverage: their choices can influence other, smaller owners and they may be consulted by smaller owners.


Impacting company behaviour requires resources, a clear strategy, patience, and persistence. This is a challenge for funds that can be reduced by collaboration, though there may be practical and/or political obstacles to effective cooperation.

The example of GPFG

The framework described above is brought to life in the specific recommendations that the Strategy Council made in its report, Responsible Investment and the Norwegian Government Pension Fund Global. These recommendations are summarized below.

Strategy Council recommendations on responsible investing

1. Clarify the objective for responsible investment. The ultimate responsibility of GPFG is to seek maximum return at moderate risk levels. The Fund's responsible investment activities should be directed at value-enhancing activities and not be a vehicle for political objectives.

2. Responsible investment should be integrated and included in the investment mandate. If the Fund is aiming for index replication, then market-wide initiatives (such as improving corporate transparency, ensuring fair business practices, pricing externalities, and improving capital market quality and efficiency) are particularly important.

3. Develop responsible investment principles and base ownership strategies on these. GPFG should be governed by one set of responsible investment principles that articulate the expectations the Fund has to investee companies on: business purpose, strategies, financing, transparency, corporate governance and the management of key stakeholders and the environment.

4. Initiate research to elevate the understanding of portfolio performance. GPFG has a responsibility to develop an enhanced understanding of which issues may affect future portfolio returns. It is important to differentiate between studying these topics from a policy perspective and investigating their impact on portfolio performance.

5. Endorse policy changes that enhance portfolio value. The type of research described above can provide insight into the need for regulatory change and new proposals on standards and public policies. Norway should be a leader, not a follower, when it comes to seeking regulatory change or the adoption of demanding standards.

6. Disclose responsible investment principles and ownership strategies. Due to its size and potential impact on companies and markets, it is hard for the Fund to strike an appropriate balance between transparency (in the interests of gaining trust from the people of Norway) and discretion about operational management of the portfolio. A partial solution is to be transparent about the Fund's responsible investment framework rather than company-specific matters.

7. Report on impacts of responsible investment strategy. Research into the effectiveness and impact of ownership strategies is a prerequisite for improvements and for effective resource allocation. It will also help build trust.

8. Exclusion decisions should become part of an integrated chain of ownership tools. Exclusion or divestment decisions should be made on the basis of the Fund's clearly stated principles and usually after all ownership strategies have been considered. They will not usually be appropriate in the case of product-based concerns.

9. Delegate exclusion decisions to Norges Bank. This is intended to ensure that the integrated chain of ownership tools is used in the most effective manner.

10. Ensure accountability and alignment of interest. It is important to mitigate conflicts of interest between the financial and non-financial objectives of the investment mandate.


In our report to the Norwegian Ministry of Finance, we presented a detailed review of the literature on responsible investment strategy and described our extensive consultations with investment professionals. We put forward ten recommendations for the Fund, focusing on the objectives and strategy for investing responsibly, on measures related to transparency and accountability, and on changes to the Fund's governance structure to facilitate a more integrated approach to responsible investing. These proposals were debated in Norway's parliament on 3 June 2014. A political majority was of the opinion that there should still be an independent Council on Ethics (outside of Norges Bank) and that it should still have its own secretariat. However, the majority supported the proposal that it should be Norges Bank - and not the Ministry of Finance -- that makes decisions on exclusion or observation based on recommendations from the Council on Ethics. The Ministry of Finance will now start to implement changes in the strategy for responsible investing based on the recommendations in our report and the deliberations in Parliament.


Elroy Dimson is Chairman, Strategy Council at Norwegian Government Pension Fund Global

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