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Private and Confidential

July Comment

Increasingly we feel two tensions critical to business and investment management and planning. The two issues of tension that will be the catalysts for change are:

• the trade-off between private property and community benefit and

• the general  misunderstanding of money and interest (the cost of time).

In the first instance, the global justice movement promotes sharing and redistribution of wealth at the same time that all its proponents value the concepts of private property. Our solution to this tension requires giving by the rich, rather than taking by the poor, which is a recognised solution in this age.

The second problem is more challenging because it is quite evident that time has value to individuals but many anti-globalisers see only the corruption of money rather than the fact that people are corrupt, not money. Our solution here is laissez-faire. Consumers are changing behaviour and thus supporting more sustainable capital applications rather than nature depleting ones. Consumer education may be encouraged, but we would prefer to avoid regulation. In the medium term, markets will proscribe the solution for us: energy will become money. (Our systems are quickly evolving so that energy becomes the global currency - the common denominator of nature. Energy is already so critical to our lives that it dominates sustainable investment strategies, provides most of our modern conveniences and is a significant ingredient in the rationale for a war. Carbon credits are monetised derivatives of nature and provide another tool that enables global energy fungibility.) While we see solutions to these tensions, unless cooperation is extended by incumbent holders of power, change will be more volatile than necessary, and possibly more so than the planet can absorb.

Activities

(Members should please register on the Forum so that access may be granted to member areas where discussions on business development take place.)

We have initiated collaboration with Spirit in Business, a foundation core to a network of professional advisors and businesses that do business with regard to planet and people as well as profit. SiB is expanding its affiliated businesses in asset management and business advisory services and we will play a role in that. It is expected that GRI Equity may focus on development of venture capital management. Management of listed companies will form a complimentary activity and is being expanded; a total corporate responsibility screen, developed by Frank Dixon of Innovest, may be employed. Spirit in Business will hold its annual gathering in Zurich in October and you are encouraged to see the agenda and consider participation. Many exceptional leaders of sustainable business, triple bottom line investing and business development will be there. The programme is here (pdf).

We enjoyed several visits from partners and guests who were able to see us balancing nature and business in real time as the harvest really gets underway. The opportunity for others to do this will be developed as formalised retreats at Ballin Temple are focussed to senior executives and investors wishing to rapidly get up the learning curve and experience sustainable business in action - bring work boots and an open mind!

Perspective and Market Commentary

July saw the handover of Iraq to local authorities and the celebration if US independence on 4th July. For some an ironic juxtaposition. Though our celebration of US independence is modest, we have personal ties (having ancestors among the founding fathers) and recognise it as an important learning point in modern history.

Geopolitics

July started with a march for democracy in Hong Kong. The significance of the 1 July 2004 rally is that Hong Kong has a people's movement. The people want not only a better economy but also universal suffrage and for their views to be heard and respected by the authorities. This is happening in China so the implication are far reaching. A lucid note by Christine Loh is here.

As mentioned last month, 2004 is a big election year as half the world votes. We could even say that most of the world votes this year if we use an economic scale. Of course the massive weight of the US in the world will be important. The polls in the US indicate an even split in popularity between blue and red. But the change in America and elsewhere is the increasingly fast movement to apartisan politics as compromise is recognised to be good and inflexibility destructive. This is complimented by the increasing interest in policy at global and community levels, but less so at national level. We have mentioned public interest polling and simultaneous policy which are good examples of the trend to using modern market research technology to ascertain people's public policy choices and put them into practice. This is complimented by more critical local governance as communities question subsidies and regional spending patterns. For a comprehensive look at globalisation try Martin Wolf's new highly acclaimed Why Globalisation Works, it may not provide solutions for problems of globalisation but it presents some alternatives and offers a framework from which to develop.

On public policy, Alan Kay's perspective on public-interest polling and the election comes in a small book, called "Spot the Spin — the Fun Way to Keep Democracy Alive and Elections Honest". An online version is here together with Dr Kay's polling critic.

Some amusing skits of political flavour can be seen at these sites: www.JibJab.com, www.bushin30seconds.org, www.moveon.org/front/.

Terror Risk and War

July was the first month of Iraqi self governance and there was more coverage of problems in Palestine/Israel than the ongoing disturbances in Iraq. But the screening of Fahrenheit 911 has been the focus of many discussions. While we are erstwhile conservative/republican supporters we have lost faith in the ethics of this movement. Fahrenheit was certainly melodrama, which is not much enjoyed though a tear may be warranted, and friends in places like Texas must especially feel upset by the show. They will say: "The choice on Iraq was simple: take the word of a madman or defend America. As far as the president was concerned, this was no choice at all. He would do the same again." Comparisons between Bush and Saddam of reduced rationality and fundamentalist motivation fall on many deaf ears.

But we had our information from the serious and well supported American Dynasty by Kevin Phillips, another erstwhile Republican, which provides ample evidence of the "Bush monarchy". What Fahrenheit did show was the blood and guts of war which have eluded news reports and our homes. It showed the primitive belligerence of young, naive troops fighting fear with rock music, a video game mentality and weapons of mass destruction! And it showed some of the quite plain deception, incompetence and cover-up of protagonists, which might have been forgivable given the magnitude of events and speed of developments, if transparent, but now look blacker than the Monica Lewinsky soap opera. Our values and technology support cooperation and compromise, and we can take Fahrenheit with a bucket of salt, but if only a couple of the clips were not fabricated they should be enough to make the rich and powerful think again about our role in the lives of people far away. Despite the melodrama, I left the cinema even more embarrassed for our (rich country/people) behaviour in Iraq, and the Middle East. (Download Fahrenheithere.)

(By the way, the UK inquiry into Iraq and WMD - the Butler report - had nothing to do with us.)

Our expectation of summer troubles noted in June's comment now seems to be shared by the US "Department of Homeland Security". The Olympics (which the WWF claims have not met environmental promises) may be a target. We hope tragedy will be modest and kept to natural disasters, like the frightful flooding in Bangladesh and north-east India.

And finally attention has turned to Sudan where many are dying in civil war.  This tragedy has been going on since early 2003 but has been obscured by Iraq.  It is devastating, up to 50,000 dead so far, though it has limited external impact and thus attracts attention less easily.  The UN now is focussing on Sudan and calm may come before year end.

Investment Management and Venture Capital

Dresdner Kleinwort Wasserstein, a leading investment bank, recently published a global strategy report entitled: The Psychology of Happiness which brings consciousness to the tough world of investment banking. See it here.

A study by UNEP Finance Initiative, “The Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing", was launched at the UN Global Compact leaders' summit at the end of June. This new "Responsible Investment Initiative" has been launched, say UNEPFI members, in the light of results of a 14-month study published last month by UNEP on the financial impacts of sustainable development. UNEPFI claims says the report shows that environmental, social and corporate governance issues affect long-term shareholder value. It also says there is a shortage of good reporting by many companies on social, environmental and governance issues. “The time is now right to develop principles to guide best practice in responsible investment decisions worldwide,” said Klaus Toepfer, UNEP’s executive director. “The world’s largest banks have the Equator Principles to guide their actions in a manner supportive of sustainable development. We believe the investor community is now ready for similar principles to assist with the complex process of responsible investment that meets investor expectations,” he said. The report looks at the impact of environmental, social and governance issues on share prices. It is an ambitious consultation exercise that aims to engage many more potential UNEPFI signatories in social, environmental and governance concerns to help frame a financial industry code on non-financial issues for use on a voluntary basis. An appropriate initiative in the month that Ken Lay former CEO of Enron was finally indicted.

There has been much talk of alpha performance accompanying hedge fund growth. Coincidentally it has been mentioned by at least three managers in conversation this month. (Alpha performance is the non-systematic or individual performance of companies and is generally attributed to management characteristics. Beta performance are the market or industry related factors. Asset managers can diversify away beta risk and seek out performance by attempting to find alpha opportunities.) The focus on alpha is appropriate but raises the important question for investors of how to find and identify it. Our approach is to focus on qualitative indicators of management behaviour as well as financial performance. The triple bottom line systems approach does this. Normally hedge funds may use technology to find timing and pricing differences or identify emerging opportunities. As all good capitalists know, the market is self correcting so that many alpha seekers will remove alpha from the market, particularly arbitrage alpha, so claims of being able to outperform should be considered carefully. We prefer an approach which screens for a broad range of qualitative characteristics and aims to systematically select businesses that will have sustainable systems, ethical competent management and low likelihood of "Enron" risk (internal deception).

Attention is drawn to Interface Inc which was in the media several times in July. It is a pioneer of sustainability and is a valuable case study. It is highlighted in contrast to the movie The Corporation which compares corporate behaviour with that of a psychopath because of the normal disjoint between action and ethic. Ray Anderson has successfully changed the whole business system of this billion dollar company over 2 decades so that it now has 80% less waste, 78% less water usage, 31% less energy use and so on.

The public markets remain lacklustre and we can expect that August will bring summer volatility or apathy. Neither are healthy trading environments but may offer opportunities. September will see renewed direction and energy, but will be influenced by the rapidly approaching US election. If there is a long term bear market, which is likely given cyclical trends, the next administration will suffer who ever wins.  And many signs of a bearish outlook are apparent including technical, fundamental and anecdotal.

An interesting view by Doug Fabian suggesting the decline of mutual funds may be found here: The Endgame For Mutual Funds By Doug Fabian, Editor, Successful Investing.

Venture capital activity is beginning to pick up as fund allocation to the earlier stage businesses is showing signs of recovery. The demand from businesses for equity capital remains robust. The Napster story continues as investors are being sued because of their connection with Napster. It appears to be the first time that a VC firm and some of its individual partners have been sued for the illegal actions of their portfolio company. Another example of ethics being forced through governance regulation because individual responsibility has not been taken.

The US's National Venture Capital Association has published a study on the economic impact of VC-backed companies. The research suggests that VC-backed companies fared better in job creation and revenue growth between 2000 and 2003, than did non-VC-backed private companies. Dan Primack of P E Week notes that the study does not mention the VC industry’s partial culpability in the bubble creation or its subsequent burst.

A useful note on business growth and the J-curve, from CALPERS, is here. Like the startup entrepreneur, investors are still unaware of the economic dynamics of business establishment. In particular J-curve performance is a normal phenomenon and declines in value should be expected as resources are consumed to build infrastructure. However, we are very cautious of the dot com model of investing: throw money at an idea and it will work. It rarely does; that's why we are cautious of start-ups and require mitigation of risks and good planning prior to consideration.

Upward pressure on interest rates continues to be felt and this is driven by inflation. Asset price inflation in the housing market is partly to blame but while UK, Spain and Ireland have strong signs of bubbling, the US market is not so overpriced.

Trade

At the end of July the WTO reached tentative agreement on how to move trade negotiations forward. The objective of removing all tariffs is now on the agenda. Ironically this is virtually contemporaneous with the US imposing anti-dumping duties on shrimp from Vietnam, Thailand, Brazil, India, Ecuador and China which will punish a key industry for these emerging economies where low wages are a competitive advantage, to the benefit of wealthy US producers which have high wages for low skilled work.

The WTO deal will cut rich countries' farm subsidies in return for developing countries opening markets for manufactured goods. WTO Director General Supachai Panitchpakdi called it a "minor triumph", which left much to be done. According to the World Bank, a final deal could add $520bn (£280bn; 420bn euros) to the world economy by 2015, if rich and developing countries cut their tariffs. Most of the benefit would go to poorer countries, the World Bank believes.

On a smaller scale, open trade took another step forward in an agreement between Thailand and Australia that reduces tariffs and investment limits. In particular, majority Australian owned companies will be allowed in Thailand, which may attract investment. The agreement many be used as a template by others in the region.

Energy

Oil prices remain high. Yukos, the massive Russian oil company, is a political football which is dampening enthusiasm for the Russian economy as well as potentially disturbing energy markets.

Pressure for change is building and power companies are really feeling the need to change their business model as authorities as well as the public call for alternative solutions. Attorneys general from California, Connecticut, Iowa, New Jersey, New York, Rhode Island, Vermont and Wisconsin, along with New York City's corporation counsel, filed a public nuisance lawsuit Wednesday in federal district court in Manhattan. The attorneys general are trying to force the power producers to cut carbon dioxide emissions and curb global warming. The companies named are: American Electric Power Co., Southern Co., Minneapolis-based Xcel Energy Inc., Cinergy Corp. and the federal Tennessee Valley Authority. The states that are suing claim those power producers own 174 fossil fuel-burning power plants that produce 646 million tons of carbon dioxide annually - about 10 percent of the nation's total.

China's energy challenges are instructive. China's booming economy has pushed up output at the country's - and Asia's - biggest oil refiner, Sinopec, by a fifth in the first half of 2004. Sinopec said processing volume was up 19%, with sales rising nearly 30%. China is seeing growth of more than 9% a year, despite state attempts to calm the economy amid fears of overheating. Soaring energy demands have led to rolling blackouts, and firms are being forced to put staff on holiday and work at night to keep demand under control. Shanghai - the economic powerhouse of central China - increased by 25% to 2,000 the number of companies ordered to switch to night working, in the face of a heat wave which means air-conditioning usage is eating into power supplies.

The World Business Council for Sustainable Development (WBCSD), a coalition of 170 international companies, says increased coordination between countries is needed to "limit the adverse social and environmental impact of motor vehicles." The report 'Mobility 2030: Meeting the Challenges to Sustainability' assesses the sustainability of 12 global automotive and energy companies products and the future of mobility with a special focus on road transport. The 12 companies involved in the project are General Motors, Toyota, Royal Dutch/Shell, BP, DaimlerChrysler, Ford, Honda, Nissan, Michelin, Renault, Norsk Hydro and Volkswagen.  (See it here.)

At the opening of a solar plant in north Thailand, the Thai prime minister announced a programme to encourage the take-up of alternative energy in the electricity-hungry country. The country’s energy minister told the Bangkok Post that his government was keen to promote the cost-effectiveness of renewable energy to be used in households around the country. Thailand is already advanced in some forms of renewable energy production. A Food and Agricultural Organisation report says that in 1997 two-thirds of residential electricity came was from renewable energy sources. Biomass is the country’s largest primary energy source with 44% of domestic energy production drawing on this source.
Twenty-eight per cent of energy in the manufacturing sector comes from renewable sources.

Africa

Africa is not often high on investors agenda. A recent report indicates some of the reasons. The report highlights the seriousness of corrupt and inefficient systems: "Even if African labour worked for free it might not be competitive because non-labour costs are often radically higher." The report can be found on the UNIDO website at: http://www.unido.org/doc/5156.

Asia

Signs of sustainability are growing in China. A new drive to "Revitalise The Northeast" has been initiated with the intention of moving from dirty manufacturing to clean services and even organic farms. This is the kind development strategy that we advocate and is ideal for China which can source new sustainable technologies and business models at similar costs to traditional offerings, but save on human and environmental costs. Nevertheless, implementation is a long way off and the track record has not been good.

The emerging scandals in the investment trust industry are another example of how easy it is to lose in China, whether local or foreigner. In the last year nearly $ 3 billion was raised by trusts with limited disclosure and plenty of hype - investors are now suffering and authorities are faced with an increasing mess of defrauded investors.

AIDS

AIDS was on the agenda in July as the International AIDS conference took place in Bangkok. Data presented from a report by the International Labour Organsation showed that it is becoming a significant cost to Asian economies. It is estimated that , even with a response, AIDS cases of 2001 will cost Asia over $ 15 trillion by 2010. While education may help, rising income at the lower end of the economic scale often results in higher crime, drug use and prostitution as a connected and wealthier economy provides opportunity. Increasing prostitution and usage of dirty needles will compound today's problems.

There as been a positive trend in funding of solutions, but the short term need for education and prevention in Asia is critical. In Thailand, where great progress was made by Mechai Viravayda's promotion of the use of condoms, it appears that complacency is now appearing among young people and awareness campaigns are needed again. Similar people friendly promotion of condom use is desperately needed in Philippines, a Catholic country, and China's need for hygiene education is untackled.

IT and CT

Microsoft announced the biggest dividend: $ 32 billion in cash plus $ 30 billion in stock repurchases.  Well done.  An appropriate move given the massive cash hoard and limited alternative uses.  It begs the question: where did all this cash come from?  It came from extraordinary margins on a monopolistic product.  And still does.  Even the $ 0.5 billion European judgement will not make the company blush.

(One of our partners, frustrated by MS, has signed up for a linux course. Another sign of movement in the right direction.)

IP telephony is a sensible way to share telecommunications overhead to reduce call charges. It is emerging globally and we have mentioned Skype previously. We are interested to have seen reports in July that Japan has pursued this market and now 7% of households use it. This will certainly benefit Japan as the cost savings are persuasive. It also highlights the attractiveness of pursuing investment in this area.

LOHAS

It was reassuring to see a high profile case of gender-discrimination settled. Morgan Stanley paid $ 54 million to settle out of court, including $ 12 million to the plaintiff and $ 40 million for others who were colleagues of the plaintiff; the remainder is for education.

In a similar vein, conservative opinion in Japan is slowly beginning to accept that the constitution will have to be changed to allow Princess Aiko to become the first female emperor since Go-Sakuramichi, who ruled between 1762 and 1771, because no-male heir is available. Another accident leading to more equity.

Similarly, Fifth Third Bancorp (ticker: FITB) finally made good on its pledge to implement the will of the majority vote on a shareowner resolution calling on the company to add sexual orientation to its Equal Employment Opportunity policy, bowing to the threat of a boycott. John Angelo, a 15-year Fifth Third customer who is gay, organized the boycott, garnering pledges in three days to withdraw almost $1 million from the bank. For more history on this issue, read the related news brief and article. Also in July, the Senate quashed Bush's attempt to make same gender union illegal.

Age equity is also making progress. A 100-year-old man who killed his ailing wife as a final, despairing "act of love" was allowed to return home to his family. Bernard "Monty" Heginbotham, the oldest man in Britain to be charged with murder, killed his wife, Ida (87), because he could not bear the prospect of her ending her days in the dementia ward of a nursing home. The judge excused him on the grounds of diminished responsibility although he ordered a 12 month rehabilitation course.

Following on the recent media attention to obesity in recent months, McDonald's is being sued over fatty chips! Of course, since the company started to rebuild itself 2 years ago many changes to the menu have improved the vitality of their offerings. The suit is useful to raise awareness of lifestyles, but is misdirected because of course McDonalds is not selling health and consumers are responsible too. However, the crux of the case is in advertising since fat reduction targets have apparently not been met.

Those capitalists of you with more liberal values will be pleased to see the Fraser Institute report which reiterates that economic freedom (eg low tax, free trade, property laws and freedom to contract) is a the key to growing prosperity. This correlates with the political parallel that democracy leads to prosperous society.

Even the Chinese are getting soft on eating animals. We read of the abattoir boss in Sichuan province who gives his livestock a spa where they fall asleep following which electrocution and slicing occurs. Nutritionists note that the meat tastes better if the animal is not stressed at death.

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