By Graham Sinclair
Mainstreaming sustainable investment: If the many investor initiatives aimed at corralling investors toward sustainability had not already made environmental, social and governance (ESG) the new normal, 2016 should do it.
Groupings such as CDP (822 financial institutions, US$95 trillion assets under management), Institutional Investors Group on Climate Change (120 members, €13 trillion AuM), and PRI (302 asset owners, 958 investment managers of US$59 trillion AuM) have continued to grow their signatory base and inflate the “big number” (see TriplePundit “$6.2 Trillion* is Not Enough” for more on the asterisk).
The investment industry organization CFA Institute just updated its CFA ESG Handbook and ESG-100 FAQs. COP21 in Paris kicked on. If all the big firms are doing it, it must be right, right?! They call it “mainstreaming," in the principal or dominant course, tendency or trend. For the longest time in the sustainable investment sector, much of the talk has been of how sustainability will show up in all investment houses and in all investment decisions, not just the niche that first acted on it. The investment industry is renowned for herding activity, so it is not surprising that making sustainability a “mainstream” investment practice has been sustainability practitioners’ goal for reaching scale and systems-level change. The underlying anxiety was some kind of inverse FOMO.
Now in 2016 the 200,000+ investment funds that investment analyst Morningstar claims to track will for the first time have ESG ratings, in a deal with ratings agency Sustainalytics announced last August. Environmental, social and governance (ESG) issues include gender diversity, separation of powers and labor rights.
Morningstar tracks the holdings of more than 200,000 global managed products, and Sustainalytics provides ESG ratings on more than 4,500 companies, allowing for Morningstar to create asset-weighted composite ESG fund scores based on company-level Sustainalytics ESG ratings. Swiss private bank Julius Baer (also “exclusive global partner” of the world electric car racing series FIA Formula E) was the first to license Morningstar/ Sustainalytics ESG scores for its fund research team.
The news of a major scorekeeper like Morningstar including ESG ratings is still flowing into the corners of the investment industry, with the European market as epicenter. (FT reported earlier this month that the “Morningstar ethical rating could cost funds billions.”) Using smartphones will be poignant: The 2016 ESG issues season kicked off in January with Amnesty International’s new campaign on cobalt mining that targets Samsung, Sony and Apple (not HTC or Xiaomi?) and their investors.
The reality of how every dollar is invested today is that ESG aspiration leads ESG execution. America's largest investment firm, Blackrock (US$4.5 trillion AuM) has been positioning itself toward “responsible investment” starting with engagement, claiming 15,000+ meetings where it votes annually and 130,000+ proposals voted on. Pointedly, Blackrock does not identify which votes are for or against company management, on which material ESG issues.
Other majors like Vanguard have not updated their ESG offering in a decade and so pre-date Twitter (yes, that is a unit of time!). State Street Global Advisors (SSgA) has one of the leading ESG practitioners but a huge portfolio to cover.
The clients of mega investment firms are more articulate about their expectations. Mega retirement plan CalPERS has four channels to influence their ESG work -- engagement, partnership, advocacy and integration into investment decisions. CalPERS has ESG expectations of its external investment managers. Great expectations. 2016 has kicked off with implementing ESG plans across CalPERS US$289 billion portfolio.
Now the clients of mega investment firms will be tracking the impacts and the outcomes. Investors are now chasing Volkswagen for lost billions from its emissions-cheating scandal, Reuters reported. In similar vein, you may expect an SEC lawsuit in the next few years based on the malpractice from some corner of a mega investment firm failing to execute the ESG-integrated mandate of its client competently. PRI promised to rank signatories' efforts, differentiating the fakers from the makers. Bloomberg reported the “five don’ts” of “investment that promise to do good.”
Pure-play sustainable investment firms are smaller. Small means agile, able to adapt to sustainability in their portfolios, hire sustainability proactive talent, and run their investment firms in a way mega investment firms cannot, or cannot do easily. Anyone working at any megafirm who has tried to order their next business card as eco-friendly will know the feeling!
MBA-101 predicts that a niche player must market their unique selling proposition as compelling competitive advantage. Pure-play ESG shops will go “all-in" -- making positive ESG investment in energy efficiency happen in all asset classes while also driving energy efficiency at head office; engaging portfolio companies on gender diversity while also being accountable to the firm’s own stakeholders on gender diversity at head office.
Like the millennials who are driving changes in how companies make and sell products, the attributes of ESG include transparency and authenticity. Millennials want to know what impact the product they buy or the career they choose has in the world. While greenwashing is evident across all types of businesses as firms cut corners to catch onto the sustainability wave, investment firms do so at their peril. Hollow reputations take years (and billions of dollars) to fill back up -- see VW. Failure is fatal. Every investment firm relies on its reputation as intangible asset in gathering client assets to manage and to generate investment returns for clients. Lose reputation and close down, either the portfolio or the firm itself.
The difficulty in making ESG happen in big firms with multi-line businesses can come from personnel who do not buy into the higher purpose. Like any firm with more than one operation, it may also come from apparent (and/or implicit) conflicts of interest. Failure may be triggered by a handful of people in a different business unit, like AIG. Questions of corporate culture arise.
In the same week that Goldman Sachs agreed to pay U.S. regulators a $5 billion fine for 2008 mortgage errors, the Goldman Sachs careers department was profiling GS global ESG head Hugh Lawson’s work on “how ESG investing is becoming mainstream in asset management.” Elsewhere, SSgA sister company State Street Bank and Trust Co. will pay $12 million to settle SEC charges of a pay-to-play scheme to win contracts with four Ohio public pension funds. Also this month, private equity mega investment firm KKR expounded on how “ESG issue management enhances private equity” at the Hong Kong Venture Capital and Private Equity Association’s Asia Private Equity Forum. The prospect of any major private equity firm in the U.S. -- with their infamous 2/20 fee model, tax advantaged principals, cost-cutting and financial engineering history -- should be expounding on the merits of ESG is anachronous to many practitioners of sustainability.
The journey for mega investment firms is longer, harder and multi-speed -- maybe even impossible. Ensuring that sustainability -- authentic in spirit and deed -- is imbued in the culture and embedded across the practices of the whole firm is the critical question. But how to find answers: Interview the CIO and ask for the fair trade espresso? Mystery-shop the firm’s investment advisor?
Mega investment firms have huge staffs and many investment strategies, and so have a lot of work ahead. Maybe the mega firm can never reinvent itself into 21st-century sustainability themes while still running so hard. GE has partly succeeded; how will ExxonMobil? Few mega investment firms have pressed sustainability thinking-and-doing deeply into the fabric of the firm and its people, processes, products, practices and performance attribution. Is sustainability baked-in at the portfolio company level? The portfolio level? The investment committee level? The head office level? In a competitive marketplace, some of this will be driven by discerning and vigilant investment clients asking questions like ‘who is managing my money?’ or ‘what is the carbon footprint of the portfolio?’
Some of this goes to the way business is done and has to be solved by regulators making the playing field level, for example sanctioning insider trading. Some will be enlightened investment veterans charting a better path, like GMO’s Jeremy Grantham. Not all investment portfolios return above-average performance to their investors. Statistically, only 20 percent can be in the top quintile of performance. We should hope for more, but set our expectations for mega investment firms in the same way. Mega investment firms are not too big to fail sustainability. Which one invests your money?
Graham Sinclair is Principal at SinCoESG LLC – Sustainable Investment Consulting LLC. Connect with him @ESGarchitect or LinkedIn.com/GrahamSinclair.