The world is becoming an increasingly complex place for investors

Fund managers need to look beyond short-term gains and become more aware of long-term risks, such as climate change, because, Emma Hunt of Towers Watson tells Mike Scott, there will be much more uncertainty to contend with from now on

It is easy to voice one's support for the idea of sustainable investment, but sometimes putting it into practice can be trickier.

The pensions consultancy Towers Watson, which has been grappling with the concept for longer than most, recently issued a report outlining some of its latest thinking.

Entitled We Need a Bigger Boat: sustainability in investment, the report says that it is getting tougher for institutional investors such as pension funds to meet their performance targets at the same time as managing risks.

“The world is becoming an increasingly complex place and we are going through an extraordinary period of transformation,” says Emma Hunt, senior investment consultant at the firm.

“This is manifesting itself in the form of factors such as resource degradation, massive demographic changes, economic imbalances and a change in the relationship between workers, consumers and the environment.

“We wanted to look at what this means for investment structures against the background of investors' increasingly short-term time perspectives.”

The report's basic thesis, Hunt says, is that with the world entering this period of significant transformation in politics, economics, society and capital markets “Plan A is probably not robust enough to carry us through the next 20 years”.

The increasing complexity means that predicting the future will become even more difficult than it is now because so many factors can have a material influence on what happens.

“Investors will not be able to rely on the traditional risk assessment of the last 20 to 30 years,” Hunt says. “The greater uncertainty and complexity makes it more difficult to model. Investors need to accept that uncertainty. There's no point them trying to control it because they will get it wrong.”

However, at the same time, investors will need to be more aware of long-term risks, such as climate change, resource depletion and other sustainability issues. To cope with this changed environment, players at all levels of the financial services sector must become more reflexive and adaptive, she adds.

The changes have implications right the way along the investment chain, with asset owners likely to change the way they think about asset allocation and how they define mandates.
“Everyone expects that over the next 10 years, investment returns will be lower so incentive structures need to reflect that,” she adds.

There will be a lot more scrutiny of asset managers' fees. “Fees as they stand are not delivering value. There is a very clear basis for those fees to change.”

While it will obviously be asset owners that drive this change, “asset managers recognise that this needs to happen, too. They just aren't going to shout about it.”

Despite the sometimes difficult nature of the sustainability agenda, interest is high, Hunt says. “We are getting a lot of interest from high-reputation corporate clients, particularly in the financial services sector.

“For many of them, this is about rebuilding trust after the events of the last few years.

“We are not seeing people doing this for purely investment-driven reasons – reputation and the feeling that this is the right thing to do are strong drivers.

“We are at the start of a re-evaluation of how the financial services industry earns its money. However, I think that many banks think they are further along the line than they actually are. There is still a long way to go.”