The adoption of groundbreaking investment practices such as Modern Portfolio Theory (MPT), and their continued evolution over the past several decades, has helped to generate substantial wealth for investors (while taking on less risk). But as we head deeper into the 21st century, it’s clear that our current models should be more vigorously questioned as to whether they are pliable enough to support our increasingly interrelated and complex financial system.
In his article, Portfolios and Systemic Framework Integration: Towards a Theory and Practice, Steve Lydenberg takes up this challenge, and powerfully and persuasively challenges MPT, calling for the development of a new investment framework linking systemic-level and portfolio-level considerations. But along with challenging conventional investment wisdom, Lydenberg also offers a compelling vision of how materiality and impact are inextricably linked. He ties these two distinct and often conflicting faces of responsible investing together beautifully, highlighting that while materiality has largely driven responsible investing’s growth during the past decade, the need to consider systemic impact is undeniable. Underpinned by his deep understanding of both capital markets and sustainability, Lydenberg calls upon the “right community” to lead this paradigm shift. He understands that the growing size and influence of asset owners and their managers means that they have an obligation to act as more responsible stewards.
In some cases the paper’s thesis is based on the assumption that the reader subliminally comprehends certain truths; for example, that universal ownership has evolved from the original concept of security- and portfolio-level considerations to incorporate a systems-oriented perspective. The Volkswagen scandal undoubtedly underscores how a single event can have broad ripple effects – with competitors, across sectors, and by calling into question the integrity of corporate reporting and our regulatory system more broadly.On the other hand, Lydenberg reminds us that his proposal is strengthened by the discernable broadening of fiduciary duty, whether it’s through industry pundits positing new theories of inter-generational responsibility or more tangible evidence provided through the U.S. Department of Labor’s recent announcement that pension fund fiduciaries can consider ESG factors in their investment decisions. But beyond advocating a systems-level focus because it’s in investors’ collective-interest, and by extension implying that ignoring systemic impact is ill-advised, Lydenberg also suggests that to do so would be irresponsible. As such, this paper is important because it begins to provide the theoretical framework to explain what some leading-edge asset owners are publically articulating – that they have a fiduciary duty not only to focus on financial security for members or safeguarding the pension promise, but also to ensure that they work to secure a world into which their plan members wish to retire. As Peter Borgdorff, Managing Director of PFZW, has noted: “A good pension is worth nothing in a polluted and unsafe world.”
There can be no doubt that our current models are ill-equipped to handle today’s investment realities; and are therefore, in dire need of a restructuring. Even Harry Markowitz, the pioneer of MPT, referred to it simply as Portfolio Theory when introducing the concept in 1952, saying “there’s nothing modern about it.” And yet, as Lydenberg points out, landing on an agreed upon framework will be a journey that requires endurance and the best efforts of RI practitioners.
While I applaud the variety of initiatives already underway, I expect an enduring, robust and impactful framework will only be possible through a rigorous debate with our most fierce critics. In a nod to John Stuart Mill’s On Liberty, which first made an impact on me as an undergrad 33 years ago this month, individuals are more likely to abandon erroneous beliefs if they are engaged in an open exchange of ideas.
Michael Jantzi is the Chief Executive Officer at Sustainalytics.
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