San Francisco’s Bay Area has a GDP of $748 billion and is growing at 4% per annum, twice the US average. If it were a country, it would be the world’s 19th largest economy, coming between the Netherlands ($822 billion) and Switzerland ($686 billion). It is home to the world’s first trillion dollar company, and 74 billionaires - the third highest concentration of billionaires in any region of the world.
But, at street level, the divide between the “haves” and the “have-nots” becomes startlingly clear.
As we heard from many senior ranking experts as this year’s PRI in Person, the annual conference of the UN Principles for Responsible Investment (PRI), investors can play an important role in helping to address inequality. It is in our interests to do so as inclusive growth means more sustainable growth - and by extension more sustainable investment returns - in the long run.
”Shareholder return maximisation has been used as an excuse to take inequality off the table. One of the areas investors can have a great deal of influence is on the relationship between companies and workers.”
Nick Robins, Professor in Practice for Sustainable Finance,
Grantham Institute on Climate Change and the Environment,
London School of Economics
Start a conversation with anyone about responsible investing today and within 30 seconds you get: “Hang on. Let me just clarify what I mean by responsible investment…” The language around this space – whether that be ESG, SRI, sustainable investing, responsible investing, impact investing, ethical investing etc etc – is so diffuse, it has become its own worst enemy.
At the heart of this whole notion is one simple principle: Long-termism.
The further down the road you look, the more the shape of the path and the eventual destination matter.
Is the world or economy going to be fundamentally different in one year? Baring another 2008-style apocalypse, the answer is hopefully no. But is the world going to be fundamentally different in five or ten years? I hope so, yes.
We simply cannot go on as we currently are. We are using up natural resources at a much faster rate than the planet can replenish; climate change is compounding the problem; our population is growing, getting older and moving around; technology is changing jobs, educational needs, our consumption habits and, perhaps most importantly, how well we understand the scale of the sustainability problem.
Why does this matter in the context of investment? Because given enough time, all of these challenges will shape our economy. In other words, they will alter the direction of the path and where it ends up. So if you’re a long-term investor, you have to account for sustainability at the heart of your investment process.
Another day, another chapter in the active v passive debate. Yes, that old cherry keeps rumbling on, but when it comes to environmental, social and governance criteria (ESG), and sustainability more broadly, it really is worth looking again at the value proposition.
Why does this matter? Because of the importance of the pricing signal – in other words, using the capital allocation process as a way of signalling to companies that those with more sustainable business practices will be rewarded with better share prices.
There are essentially two ways investors can influence companies to improve their business practices: stewardship and valuation.
Stewardship is the most direct mechanism. Portfolio Manager A talks to Company B, asks questions about how the company might improve their record, a constructive dialogue follows, and then Company B goes away and takes some positive steps to improve. Portfolio Manager A has subsequently influenced the company to improve its record on ESG issues. Reality is of course rarely this simplistic, but the key part of this process is the dialogue and direct interaction between the investor and the company.
The other way investors can influence companies to improve their business practices is through the pricing mechanism. If enough fund managers are using ESG criteria in their stock selection process, then we should see a feed-through effect in stock prices so that companies with better ESG scores start to outperform those with low scores.
This is a vital step in the mainstreaming of ESG and sustainability because, if this pricing signal is working, then the risks and opportunities associated with extra-financial factors would automatically be captured in the stock price. By extension, investments managed passively against traditional market-cap benchmarks would capture the same information. And, at that point, investors no longer have to make a conscious choice about whether to integrate ESG into their portfolios or not. It would already be built in.
So how do we get to that point?
Letter to the FT, printed 28 May 2018
It is great to see such positive traction for sustainable investments as reported in your piece (“Ethical funds reach record high in the UK”, May 24), especially given their potential to outperform. However, it is important to understand the difference between ethical investments and those that screen based on environmental, social and governance criteria. Ethical investing is a values-based decision. It is generally made regardless of the impact on a portfolio’s risk/return characteristics. This approach typically excludes entire sectors from a portfolio, such as tobacco, controversial weapons, fossil fuels or pornography. By contrast ESG investment looks at how companies are run, differentiating between companies in the same sector. The portfolio effect of these two strategies can be markedly different. Importantly, ethical exclusions do not necessarily improve the ESG characteristics of a portfolio, and ESG does not compromise return potential versus mainstream investments. As the world moves towards a more “sustainable” economic and social model, ESG screening can help identify how aware companies are of the risks and opportunities this transition presents. And, over time, it can tell us who is adapting and who is not. Why is this important? Well, if you’re in a car heading for a brick wall, the sooner you apply the brakes, the better your chances of avoiding major injury or avoiding the wall altogether. This is what ESG investing helps us do. As such, I would contest that the trends highlighted in your article show investors are looking to invest in ethically sound businesses. They are, in fact, investing in businesses that are geared towards the return drivers of the future. And that is just sound investment.
West Meon, Hants, UK
There’s a new frontier in the battle to transition companies to more sustainable business models: lobbying.
Shareholders are waking up to the damaging effects that certain lobbying activity can have on the growth potential of their portfolios over the long term.
Take the case against Rio Tinto, for example. The company’s website highlights its commitment on climate change thus: “Rio Tinto supports the intent of governments to maintaining “a safe and stable climate in which temperature rise is limited to under two degrees Celsius”. The company signed the Paris Pledge for Action supporting the agreements made by 195 governments in Paris at COP21.
It seems a little contradictory, therefore, that the company spends an estimated A$2 million on membership fees to the Minerals Council of Australia (MCA). This organisation and others like it have played a significant part in slowing down the progress on climate change legislation in the country by adding to the prolonged deadlock in energy and climate policy, particularly as it relates to coal.
The action against Rio Tinto, which includes resolutions to be heard at the mining firm’s UK and Australian AGMs in April and May, is being led by the Australasian Centre for Corporate Responsibility and has attracted co-signants including AP7 and the UK’s Church of England Pension Board.
Adam Matthews, head of engagement at the Church Comissioners for England and the CofE Pensions Board, says lobbying activities of investee companies is an issue of particular importance to asset owners as “a lot of trade associations impact governments’ ability to regulate on climate change”. He points not just to the ethical considerations, but also the implications for corporate transition risk.
If companies’ failure to transition to low-carbon and sustainable business models undermines the potential to generate risk-adjusted returns over the long term, then companies’ efforts to slow down related legislation should be an area of growing concern. Especially as it is shareholders’ money these companies are spending.
The shareholder payout boom continues, but can companies afford the high levels of dividends and shareholder buybacks? Are investors encouraging companies to accelerate their own demise, rather than acting as responsible stewards of capital?
Does anyone else have a growing sense of unease about the level of dividend payouts and share buybacks going on at the moment? They are a significant part of what is driving valuations of many US banks, for example, but they speak to a lack of sustainability over the long-term.
Are these companies investing enough for their future growth? And if they are borrowing to finance these pay outs to shareholders, does that spell doom for the years to come?
Investors should be careful about
celebrating the payout bonanza.
'ESG' funds that integrate environmental social and governance criteria into how they select investments are not 'fluffy'. They are not necessarily designed to 'do good'. They are about improving risk-adjusted returns.
Sitting in a conference on climate change recently, I was struck by the persistent perception that ‘ESG’ is about ethically responsible investment. That it is designed to ‘do good’ rather than generate outperformance. This is perhaps the biggest barrier to mass uptake of funds that integrate environmental, social and governance (ESG) criteria into their stock selection.
It’s a simple taxonomy problem.
ESG v impact
The issue stems from the fact that, as yet, the evidence to show ethical or impact investments outperform traditional benchmarks is inconclusive. Yet, for ESG, there is a highly compelling and growing body of evidence that shows it outperforms over the long run.
The reasons for this are intuitive.
“If you’re not looking at climate change,
you’re not doing your job as an investor.'
Sandra Carlisle, head of responsible investment,
HSBC Global Asset Management
Thought leadership is one of the most abused terms in asset management. Its role is critical to the future of the industry, particularly for active managers. It will help define who wins and who loses as the competitive landscape shifts. Ultimately, it will determine who becomes too intelligent to fail.
Investing is an inherently long-term game: I sacrifice today because I know I will need money tomorrow. But tomorrow is a foreign country. They will do things differently there.
As a saver, I am more likely to trust my money to someone who can demonstrate that they have thought intelligently about what tomorrow might look like, and what will or won't make money in that new world.
A quick cuppa with Fiona Reynolds, Managing Director, the Principles for Responsible Investment (PRI)
Hello Fiona. At the PRI In Person conference in September, one of the main take-aways from the various conversations I had is that considering environmental, social and governance (ESG) factors into investment analysis is becoming more mainstream. Did you get the same impression?
Yes, ESG is becoming much more embedded across the industry.
One of the biggest hindrances to effective ESG integration is that it can still be seen as an after thought to the main investment process. Fund managers can have separate ESG teams that are not embedded in their portfolio management teams. Portfolio managers might be talking to companies about very different things from the ESG team and they may not always be joined up. That lack of cohesion is a big hindrance.
Increasingly, though, investment teams are finding they either have to understand ESG much better, or the ESG analysts sit within the portfolio management team. This is a really important development for getting responsible investment front and centre, which will help the whole industry.
Using tuition fees to plug the Universities Superannuation Scheme’s £17.5bn pension deficit is a clear example of how the transfer of wealth from young to old presents a real threat to long-term societal and economic sustainability.
The fact that the Universities Superannuation Scheme (USS) gained an impressive 20.1% in 2016-17 and meaningfully cut costs has been largely overlooked in the press. Focus has instead centred on the growing deficit, which reached £17.5bn, making it the largest pension black hole in the UK.
While I can empathise with USS’s dilemma - despite generating 12% returns a year over the last five years, the staggering growth in their liabilities has been largely driven by falling interest rates and lower yields on UK government bonds, factors that are outside the scheme’s control - it raises alarm bells about the long-term prospects for Britain’s economic and societal sustainability.
The scheme has yet to make clear how it plans to plug that hole, but in the meantime, experts have pointed to tuition fees as part of the solution. The options being presented are that either fees have to go up, or fees stay the same, but more money is diverted away from teaching to fund the pension promises made to USS’s 390,000-strong academic membership.
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A quick cuppa with Faith Ward, Chief Responsible Investment and Risk Officer, Environment Agency Pension Fund