"Perhaps it is better to be irresponsible and right, than to be responsible and wrong,” mused Sir Winston Churchill.
Thankfully, institutional investors probably don’t have to worry about this sort of casuistry. Responsible investing comprehends fiduciary responsibility to beneficial owners as well as to the environment and society. The United Nations Principles for Responsible Investment (UNPRI), set out in 2006, were a milestone in integrating Environmental, Social and Governance (ESG) factors into investment risk-management processes, bracketed by studies from UNEPFI which sought to quantify their effect on company values. As one of the studies put it, “Naturally, performance speaks loudest for most investors”, and over the long-term almost everyone agrees that these responsibilities are well-aligned – as the trillions of dollars that back-up the signatures on the UNPRI, the Carbon Disclosure Project (CDP) and other initiatives suggest.
Many pension funds’ memberships are large and diverse enough to mirror society-at-large, so what benefits society benefits them. But common sense suggests that financial benefits will also follow.
“A well-led company is going to be a successful company over the long-term, and you can’t have a well-led company that is bad in its relationships and damages its brand by losing trust in its values,” observes Mark Goyder, founder director of Tomorrow’s Company, a think tank dedicated to interrogating the concept of ownership in a modern economy.
Tomorrow’s Company’s Annual Lecture this year was given by Matthew Kiernan, CEO of Innovest Strategic Value Advisors. Backed by Dutch pension giant APG, the firm helps clients responsible for $7000bn (€5505bn) construct portfolios that integrate sustainability and finance by tracking company performance on over 120 factors not captured by traditional securities analysis. PricewaterhouseCoopers says that about 75 per cent of a company’s value is driven by these “intangibles”, according to Dr Kiernan.
“Management quality is arguably the number-one intangible,” he says, “and ESG issues are among the toughest, most complex management challenges of the 21st century. Therefore, companies with superior positioning and performance on ESG factors tend to be more forward-looking, more agile - better managed in general. Show me a company that manages these issues better that its competitors and I’ll flat-out show you a better-managed company.”
Crucially, these factors are manageable while many drivers of stock-market return are exogenous and, to some degree, out of owners’ and managers’ control. The difference between the two has never been in sharper relief. The International Corporate Governance Network (ICGN) recently identified corporate governance failings as “significant” contributors to the global financial crisis, and maintained that enhanced practices should therefore be integral to restoring confidence to markets.
“The financial crisis has been a trillion-dollar wake-up call,” agrees Dr Kiernan. “Our financials team was very early to the subprime issue: we were writing to our clients in October 2006 saying that there was something dodgy here. Without the lenses of sustainability we would not have asked tougher, better questions than the ones the rest of the Street was asking, which enabled us to pick up on that.”
Add to the general dissatisfaction with failed financial culture a growing awareness of ESG issues among influential investors, businesses and consumers, new ESG disclosure standards and better-resourced NGOs, and the shift in the economic centre of gravity to emerging markets where ESG risks are highest, and you have a compelling case for re-thinking investment behaviour.
“Today investors like APG, CalPERS, CalSTRS, FRR, PGGM, CPPIB and USS are exceptional, but one day soon this will be the norm,” says Dr Kiernan.
But while the assets inside the tent are big, the assets outside the tent are much bigger. Jane Goodland at Watson Wyatt reminds us that attitudes and approaches to ESG investing vary depending on the type of institution concerned, its governance budget, its trustees’ and fiduciary’s attitude to risk and, most legitimately perhaps, its time horizon (mature pension funds, or those aiming for an insurance buyout, are not investing for the long-term). Some just don’t buy it.
“The personality of fiduciaries is very important – the enthusiasts will start the debate, take it to the trustees and make things happen,” says Ms Goodland. “It’s difficult to establish where value is being created in these exercises, and for some trustees that’s just going to be a bit too intangible. As products mature and managers get better at this, there is every hope of making this far more integral to the standard institutional investor’s portfolio.”
Speaking at a Tomorrow’s Company event, Sir Mark Moody Stuart, the chairman of mining giant Anglo American, acknowledged that while most people in industry know instinctively that responsible business is correlated with profits, that does not help “a responsible investor looking for indicators”.
