I have a number of observations to make regarding RI’s March 19 account of some of the initial reaction to Generation’s latest think piece on “Sustainable Capitalism”. Link to article While I didn’t find the reported responses terribly surprising, I did find them profoundly dispiriting. Where to begin?
First, to hear the old canard of “fiduciary responsibility” trotted out yet again as a major excuse for failing to act on the paper’s eminently sensible recommendations was perhaps the most disturbing of all. That these views spring from North America should surprise no one. But there is now a wealth of academic and practitioner literature around which should have long ago consigned that particular excuse to the dustbin of intellectual history. This is not, by the way, to imply for a moment that that selfsame excuse isn’t actually trotted out every day by investment committees, asset managers, consultants and the like. It clearly is. But consider this: if one doubts that the practical definition of “fiduciary responsibility “ is an organic, evolving construct, one should reflect on the fact that, not so many years ago, investing in public equities was generally considered to be clearly beyond the pale of fiduciary responsibility. Times change, social attitudes change, polar ice caps melt, and fiduciary practice must evolve accordingly. I continue to find astonishing the degree to which otherwise intelligent people can contort their thought process. They apparently believe that completely ignoring longer-term risk and return drivers such as climate change, income disparity, resource scarcity, and changing demographics while investing other people’s money constitutes a lessrisky approach than having the additional insights about a company’s true risk profile and value potential! Second, the objections raised in the article highlight what to me is another fundamental but largely unaddressed phenomenon: the impoverished current state of the “conversations” between companies and their investors around sustainability issues and performance. It seems to me that: a) those conversations are far, far too rare; and b) on those infrequent occasions where they do occur, one side generally speaks in English, the other in Sanskrit. To the first point: how many CEOs have you met who complain that financial analysts never raise sustainability topics with them, and that the markets neither understand nor reward their companies’ often prodigious and effective efforts in the sustainability space? In my case, the number must be literally hundreds. To the second point, it is clear that the two sets of actors are not currently communicating in a language the other can understand or take action upon. As a general rule, most CFAs don’t necessarily understand what a megaton of CO2 is, nor why a company reducing emissions has anything whatever to do with its competitiveness, profitability and prospects as an investment. If companies truly want the analysts to pay attention, they will have to spell that out for them. So in my mind, the ongoing “one report or two“ integrated reporting debate largely misses the point. To me, the real focus should be on the nature and quality of the sustainability reporting, wherever that information is ultimately lodged. That said, I remain a fan of integrated reporting , if anyone asks…..Third, the Generation
paper’s central preoccupation is, quite rightly, the markets’ excessive short –termism. When 70% of the trading volume of the New York Stock Exchange (and 77% in London) is generated by high-frequency traders, and Chief Investment Officers’ investment horizons typically range from three to twelve months, it is difficult to fathom how the markets could possibly be anything but short term in their focus. But herein lies the opportunity : instead of bemoaning that fact, largely on normative grounds (“it would be a better world for our children and grandchildren if everyone took a longer-term view“), perhaps it is time for a new strategy. Indeed, I would venture a guess that it’s a strategy which Generation and others like them are already employing: “time arbitrage”. Instead of appealing vainly to Wall Street’s and the City’s better natures (!!) and higher social calling, it might be better for
investors to simply take advantage of market myopia. I would argue that, while the markets’ short-term focus may be the mother of all behavioural finance challenges,it also provides an historic investment opportunity. By ignoring or at the very least under-valuing longer term risk and return drivers (ie, sustainability factors), the market has created a series of systematic mis-pricings in the public markets. Investors who understand this, and whose clients truly have the internal fortitude to “hang in” for the long term, despite the inevitable short-term performance bumps, can take advantage of these mis-pricings and build market-beating portfolios. Perhaps that would be the best antidote to short-termism: out-perform the markets using an explicitly long-term strategy, and let it be known that one’s investment horizon itself is an important source of one’s information advantage.
To summarize, I applaud the Generation paper enthusiastically. That it should have provoked the sorts of criticisms which it apparently has tells us more about the critics than the paper.
Matthew Kiernan is Founder and Chief Executive of Inflection Point Capital Management