Hugh Wheelan: What’s The Value of Responsible Investment?

Earlier this week, RI published an article by Erik Breen arguing that responsible investors needed to take a good hard look at themselves to rediscover their purpose and path. A few days later, an excellent guide, albeit with caveats, has been published that is required reading and could help them do so. The new report, titled “The Value of Responsible Investment” is published by the Investment Leaders Group (ILG), a small and focused group of institutional investors, hosted by the University of Cambridge Institute for Sustainability Leadership (CISL), and supported by financial economists at the Cambridge Judge Business School (see link at the foot of the article).
Another report, you sigh…..
Well, yes, but an important one I think, and one of a number published recently (I flagged up the Ito report from Japan earlier this week), which along with the UK’s Kay Review are grappling with the why and how of more responsible finance at a philosophical, cultural, political and investment level, and whose impact I think could be important over time and behove responsible investors to digest.
Philippe Zaouati, CEO at Natixis Asset Management’s responsible investment brand, Mirova, and Chair of the ILG, re-iterates the ‘problem’ well in the report: “In spite of a widespread rhetorical commitment to responsible investment principles, market dynamics remain pre-occupied by the short-term, and the majority of investment does little to answer the challenges of our time. The ILG seeks to change this, first of all by defining the value of responsible investment and then working out how to promote it.”
The report identifies three clear, simple ‘mutually supporting motivations’ which form a philosophical backing of RI – service to society, enhanced returns, and economic imperative – and which, if harnessed, could lead to genuinely sustainable corporate business models being supported in the real economy. Dr Jake Reynolds, Director of Business Platforms at CISL, notes: “In a world that neglects to account for social and environmental costs on corporate balance sheets – costs we know can ultimately impact value – responsible investment can be seen not only as a smart investment strategy but as an essential response to growing sources of systemic risk.”Fine words, but how to get there? On a first read (and the report deserves a more thorough assessment), it makes a good fist of outlining the moral imperatives of responsible investment (ethics, externalities, trust, confidence, rule of law, mutual dependencies of financial and non-financial value) and outlining where RI could fill the role opened up by the increasing realisation of the shortcomings of markets and the ‘but what to do?’ question.
It argues that there is good reason to believe that the public cares sufficiently about having a well-functioning, fair and secure society, and wants their money managed consistently with these interests while obtaining satisfactory financial returns. It does less well in posing the counterfactual: why then aren’t large volumes of assets going to the RI equivalent of ‘fair-trade’ (fair-trading perhaps?) investments? Why aren’t providers selling products to serve these consumer notions? Why is public knowledge of RI so weak?
On the topic of ‘economic imperative’, the report notes – as many have before – that given their role managing long-term public savings, large asset owners and asset managers have a responsibility to avoid systemic risk in the economy. It does well in testing the thesis against the academic literature and existing investor practice (porfolio construction, passive investing, risk-adjusted returns), while underscoring the potential advantages. It also outlines the steps in mandate design and duration, manager surveillance on ESG performance, better strategic research, joint low carbon public/private funds, where action is needed, and taking place, albeit slowly. In my view, it could have majored a bit more on what it calls its high-level ‘value creation framework’ for institutional investors, which consists of three pillars: a set of fundamental beliefs about how the economy and the market work; a view on their ‘sustainability conviction’ (the strength of their belief that sustainability is financially relevant); and clear principles and ground rules concerning their own portfolio and governance. This is an area where heavyweight economists such as Andy Haldane, Executive Director for Financial Stability (and soon to be Chief Economist) at the Bank of England have done great joined-up economic thinking that long-term institutional investors should be measured against. This week, Haldane reportedly told an audience that
short-termism at big listed companies, including myopia on payouts to CEOs and dividends for shareholders, was clearly contributing to inequality: “Tomorrow’s growth comes from investment today….if we are to tackle this growth inequality crisis, then perhaps not the worst starting point might be to start looking at corporate governance structure. We have clear evidence that inequality sows the seeds of future financial crises. We have pretty clear evidence inequality retards medium term growth,” Haldane was reported as saying by Reuters, before pointing out that it won’t be easy to get shareholders focused on the long term when they typically only hold a stock for six months.
Broadly the same ‘economically damaging inequality’ arguments form the backbone of this year’s unlikely bestseller, Capital in the Twenty-First Century, by French economist Thomas Piketty. In this vein, Adair Turner, the former Chairman of the UK Financial Services Authority’s post Piketty analysis on wealth debt, inequality and low interest rates is worth a read:
Link to report
Haldane’s recent speech titled The Age of Asset Management Link to report is also required input.What disappoints in the ILG report, however, is its ‘collective action and response’ recommendations. They focus on further developments in areas like environmental thematic and infrastructure funds, fiduciary duty and ESG integration benefits; all vital subjects, but where good work is already being done by a variety of organisations. I would have preferred to see an exploration of where better links can be established between existing RI initiatives to reinforce their public efforts/visibility, or where more research/testing could be done on the institutional ‘taboos’ of responsible investment (why do we tend to be preaching to the converted?) and the cultural/marketing barriers to progress. RI needs to make the jump from being a pragmatic arbiter between ever-greedier, shorter-term markets and the need for society to have a longer-term ‘sustainable’ common sense economy. It needs to become a rational economic choice in itself. As Piketty, Haldane and Turner attest, the economic ‘air du temps’ is changing. Responsible investment should be clearly feeding into that, given that it has been making many of these arguments for decades!

Link to The Value of Responsible Investment report