On October 9th, 2012, TSSS began its 6th season with an animated presentation and discussion with Dr. Matthew Kiernan, President and CEO of Inflection Point Capital Management and author of Investing in a Sustainable World and The 11 Commandments of 21st Century Management.
Environmentally irresponsible investing
Dr. Kiernan challenged the audience to imagine a world where investors universally recognize the merits of an approach that considers environmental and social governance (ESG) as one that is unambiguously the right thing for the environment, for people and for investments. A vision of such a world, at this point, requires significant powers of imagination – but why? Why are trillions of dollars invested in world markets with little if any consideration of environmental or social concerns? Why does the UN Staff Pension Fund, the World Bank Staff Pension Fund, the Gates Foundation, and even the Nature Conservancy invest their dollars with absolutely no criteria for sustainable investing? When research studies, including one by established and traditional Deutsche Bank, consistently show conclusive evidence linking superior company sustainability performance with superior financial returns, why does the investment world continue to steadfastly cling to outdated models of analysis that haven’t changed in any significant way in over 30 years?
Cognitive impairments and myths
The answers to these questions lie in a series of cognitive impairments and myths that were summarized by Dr. Kiernan. Despite research to the contrary, there persists a view in the investment community that ESG considerations are at best immaterial, and at worst actually injurious, to financial returns. Investment professionals will thus claim that to consider such factors would actually be incompatible with their fiduciary responsibility (despite clear evidence to the contrary, as evidenced in the 2005 Freshfields Report which looked at case law and legislation determining there is no dereliction of fiduciary responsibility in looking at these issues as they can (and do!) influence risk/return.)
Another persistent myth is that ESG research is inevitably more imprecise and unreliable than mainstream investment research.
Another persistent myth is that ESG research is inevitably more imprecise and unreliable than mainstream investment research. And yet, while financial analysts consistently claim “Management Quality” to be the primary driver of company performance, they are also consistently hard pressed to define how management quality is measured – this does make one wonder about the question of ‘imprecise’ research, doesn’t it? This double standard is not the only one that exists when comparing traditional mainstream investment analysis with one that considers sustainability – “sustainable” strategies have to work ALL of the time or they tend to be discredited while mainstream approaches generally work 30% of the time, and that is considered acceptable performance.
So, we must ask ourselves, how do we combat these double standards, myths and cognitive impairments? First, we must recognize that investors are well aware that if they do fail, it is better to do so using conventional analysis techniques – the truth is that often people are far more concerned with managing career risk than investment risk. We must find a way to shift the investment community perception of reality to one where the career risk lies not in the choice to consider sustainability concerns but rather in the choice to ignore them.
21st century global megatrends
There is no doubt that the 21st century presents a new global reality for investors. Kiernan discussed global population growth (90% of that growth in Global Emerging Markets (GEMs)) as the world economic centre of gravity shifts to GEMs while mature economies face stagnation and low growth. There is increasing demand for scarce raw materials, significant energy demand growth, growing demand for food and pressure on land resources and biodiversity, dramatically increasing urbanization and infrastructure demand, tightening regulatory and taxation regimes for pollution and climate change, changing consumer demographics with an ever expanding middle class, and significant global healthcare burdens. These powerful global megatrends are creating an entirely new set of ‘non-traditional’ risk and return drivers for companies that we can term ‘sustainability’ factors. Kiernan described a binary decision facing investors: “Check your watch. It’s the 21st century. Do you want to invest considering that fact or not?”
Kiernan’s answer for investing in the 21st century is to embrace “Strategically Aware Investing” (SAI). He coined this term to both overcome the “cornucopia of acronyms that afflicts us” (such as ESG, SCR, SRI, etc.) and to reframe the debate to be one that goes beyond the myths and cognitive impairments that have plagued the push for ‘sustainable’ investing.
Strategically Aware Investing
Strategically Aware Investing recognizes that investors, their research and their analysis techniques must understand and reflect today’s world. SAI recognizes that investment professionals must be aware of the modern reality of growing stakeholder influence, greater investor awareness, a new fiduciary paradigm with rising stakeholder expectations, greater information transparency and real-time global communications. SAI clearly considers mainstream investment principles, such as financial results, but also recognizes Kiernan’s assertion that 75-80% of companies’ true risk profile and value potential lies below the surface, and cannot be captured by traditional financial analysis. SAI analyzes all factors that contribute to risk/potential: innovation capacity, adaptability and responsiveness, environmental sustainability, human capital and organizational capital. These are the factors that must be considered if investors want to define the out-performing companies of the future. And, not surprisingly, many of these factors will show high correlation with management quality, already defined by those in the mainstream as the primary driver of company performance.
A paradigm shift
How can we push the investment community to embrace SAI? Kiernan explained that we must restore the integrity of the “investment food chain” – the owners of the assets should be at the TOP! We must educate, train and empower fund trustees and investment consultants, and if money managers are not willing to be SAI savvy, then fire them! We must create incentive structures that encourage innovation and experimentation, and we must radically restructure business and management education (e.g. MBA, CFA) to integrate ESG models.
As our world changes and evolves, so must our investment strategies.
As our world changes and evolves, so must our investment strategies. Both the complexity and velocity of change in companies’ competitive environments are accelerating dramatically. New skills and mindsets are required to compete successfully. Traditional financial analysis is of only limited use in helping investors identify those companies that are the most innovative, agile, and forward-looking in this emerging environment. By contrast, companies’ ability to manage sustainability-driven risks and opportunities better than their competitors is proving to be an increasingly robust proxy and leading indicator for these new skills and mindsets.
Consider Kiernan’s assertion that current research and analysis shows significant variation among company-specific exposures to emerging megatrends-driven risk/return factors (as much as a factor of 30 within companies in the same industry!). There is little doubt that any responsible investor must consider a holistic SAI approach.
The beauty of Kiernan’s SAI approach lies in its full integration of forward-looking sustainability insights with more traditional fundamental and technical financial analysis – from the very outset. Investors would be wise to heed Dr. Kiernan’s call for change – or start looking for a new line of work, where their reluctance to evolve to a changing world might be more appreciated. Speaking of the dinosaurs…
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Toronto Sustainability Speaker Series (TSSS) is widely recognized as Canada’s premiere forum for dialogue and problem solving among sustainability professionals. Each year over 1000 sustainability change agents attend TSSS events to exchange ideas, to network and to be inspired by leading companies that have integrated sustainability into their business practices. Please click here to learn more.