Two powerful impressions will stay with me from the 2012 PRI-CBERN Academic Conference on responsible investment. Firstly, the energy and commitment of the academics and practitioners who came together to present, debate, agree and disagree make this a unique field. Secondly, the diversity of perspectives and interpretations of what ‘responsible investment’ actually is is alternately stimulating and frustrating. What is the balance of ‘value’ and ‘values’? Is the purpose of RI to change ‘the system’ fundamentally, or to ameliorate pragmatically from within? How do we measure impact and effectiveness?
This diversity is reflected within PRI itself, with a wide range of perspectives among signatories. Yet despite this there is a ‘centre of gravity’ among signatories on what we’re trying to do. Essentially we’re exploring the territory where ‘value’ and ‘values’ overlap – the zone where the way companies address and respond to environmental, social and governance issues generates risk and opportunity that have financial implications. As climate change bites, populations age, supply chains globalise, competition for talent sharpens and resource scarcity makes itself felt there are more and more situations in which values and value look like opposite sides of the same coin.
One way of thinking about the long-term objective of responsible investment is that it is seeking to increase the size of this overlap – the degree of alignment between long-term financial and fiduciary interests, and the long-term interests of society at large.
Until now the ESG community – now an industry – has addressed the agenda predominantly either in the form of bottom-up stock-picking or top-down thematic investment opportunities. In stock-picking mode we construct lists of ‘E’, ‘S’ and ‘G’ issues, devise KPIs for company reporting and data collection, crunch numbers and narrative information, and try to judge whether company A is better positioned than company B. In thematic mode we invest in specialist funds and assets – renewable energy, resource productivity, healthcare – that are positively exposed to global sustainability trends. In either case we are on a hunt for alpha.
But then there was the financial crisis, and we realised that ultimately we all depend on the health and stability of the market as a whole. A little extra alpha from ESG-driven stock-picking pales into insignificance if the whole market falls by more than 20% and all assets are correlated. Moreover, we’ve learned that trying to factor long-term ESG issues into investment decisions just isn’t always possible if investors still expect short-term returns from companies and use conventional benchmarks.
So the ESG world’s attention is turning to beta and not just alpha. As the UK’s Kay Review of Equity Markets put it recently,
‘Returns to beneficial owners, taken as a whole, can be enhanced only by improving the performance of the corporate sector as a whole. Returns to any subset of beneficial owners can be enhanced, at the expense of other investors, by the superior relative performance of their own asset managers. Asset managers search for alpha, risk adjusted outperformance relative to a benchmark. But savers collectively will earn beta, the average return on the asset class’.
If it’s now a beta story and not just an alpha story, what questions do we need to ask? Here are a few to get the ball rolling:
- How short-termist are companies really?
- Have we got hard evidence on how, and how much, this depresses returns to long-term investors?
- Can we develop the concept of ‘sustainability smart beta’?
- How can we design new mandates to reflect long-term sustainability – e.g. with new benchmarks?
- How do we align the incentives right along the investment chain from asset owners through to companies, focusing attention at every stage on the issues that really matter in the long term (while not neglecting the need for some short-term performance too)?
- How far, and over what timescale, is it in long-term investors’ financial interests to internalise externalities?
- What happens to ‘values’ and the public interest when there’s no financial case? Is this where the state comes in?
A research agenda, perhaps?
Director of Responsible Investment, PRI
11 October 2012