This is my take on how responsible institutional investors act, in practice
One of my ongoing research topics is “ESG,” an acronym for issues that affect investment indirectly. “E” stands for “environmental,” and relates to issues that affect the depletion of natural resources and their sustainability for future use. “S” stands for “social,” and relates to issues that are of concern to the future of society, such as human rights, consumer protection and diversity. “G” stands for “governance,” and includes issues relating to how companies are run, such as the power/management structure, executive compensation and employee relations.
In my Post # 97 I said that while some people consider these to be moralistic issues, others don’t. Regardless, if they affect asset prices and prospects, they need to be taken into account in making investment decisions, whether the relevant time horizon is long (they’ll affect prices some time, but don’t seem to do so now) or short (they affect prices today). And so my interest in these issues is partly to understand the issues better and partly to understand how they affect individuals’ investment choices.
A private webcast recently had a small number of very well informed people discussing whether current institutional ESG investment practices are just box-ticking or whether they’re designed to have an actual impact. This was a virtual breakfast roundtable in London organized by Avida International (on whose advisory board I have served for some years). It was hosted by Avida partner Bart Heenk, who made the arrangements. The discussion was moderated by Sally Bridgeland, with Dame Elizabeth Corley making the substantive opening remarks before the dozen viewers joined in. Elizabeth and Sally are not only in the forefront of the subject; they have also had distinguished careers in multiple dimensions. And Elizabeth chairs the board of the Impact Investing Institute. So yes, there was a lot of substance in the hour or so involved.
These were the key points I remembered.
(1) Don’t get bogged down debating definitions of ESG. Use a definition that matters to you, and is relevant to how you think about these issues. It doesn’t matter if it’s a little bit different from what others adopt. (Now there’s a practical start!)
(2) There are many levels of execution, and there’s a useful way to classify them. The slide which this link leads to (Spectrum of Capital) explains them. Here’s my take on them.
It’s useful to distinguish three levels of involvement, tagged ABC.
A involves avoidance. You don’t invest in the related companies. By staying away, you have no exposure to practices you don’t approve of, and avoid any associated risks that may affect the price. At this stage you don’t own any positive action.
B involves a focus on benefiting all stakeholders. Here you engage with the company. This can be done even with a so-called passive (that is, indexed) portfolio, because the mere fact of holding an asset enables you to engage constructively as a shareholder.
C involves contributing to solutions to society’s ESG problems, through companies that are themselves actively engaged.
All of A, B and C are suitable for fiduciaries, that is, those who have a responsibility to manage a portfolio in the best interests of their investors. But if you are managing your own money (or are philanthropic in your outlook or practices) you can go further. You can look at situations where your expected return is lower, or your potential risk is higher, than the market average, because your goals now involve not just investment risk and return but also addressing societal challenges. It’s that aspect that is open to those responsible for their own investments, or at any rate for defining their own goals. In other words, for them it’s not finance first, it’s impact first. And that’s feasible for individuals, if you’re so inclined.
(3) How would you measure the impact? One point was made strongly: focus on output, not on input. In other words, look at results, not at analysis. This is particularly relevant for trustees who select managers to invest their portfolios. What you should look for in these managers is not their process (which they’re all good at explaining), but their impact. And that’s impact not in terms of pretty stories, but in terms of broader evidence.
In turn, that leads to the question of how impact can be measured. That’s a challenge, a subject still in its infancy. When there’s progress on broadly accepted measures, I hope to be able to report on it. Meanwhile, the website www.impactinvest.org.uk shows a 2019 “Report on technology-enabled impact reporting practice across the investing chain” that contains practical examples of companies that are in the forefront of doing this.
(4) In defined contribution plans it’s feasible to accommodate the desire of many members to have their investments reflect ESG practices. The problem is that, while those members want involvement in a general sense, they typically haven’t any idea of what exactly this means, or what’s feasible, or how to go about it. So simply asking them for their ideas is typically a hopeless cause: it’s too open-ended a question. If you’re going to ask, make sure you put your questions in the most straightforward language that can be understood by all. And offer a few choices, at most. The most practical approach is probably to design a default option that gives them broadly what they seem to want, and then they can simply say yes or no to that default option. Those who want to go further on their own usually have the additional option to do so.
It seemed to me that, given the knowledge of the participants in the discussion, I was privileged to look at the state of today’s art on ESG investing. If you are aware of deeper thinking or more practical action on ESG, do tell me about it.
There are many identifiable levels at which investments can be structured to take account of ESG issues. Measuring the impact is a subject still in its infancy.
I have written about retirement planning before and some of that material also relates to topics or issues that are being discussed here. Where relevant I draw on material from three sources: The Retirement Plan Solution (co-authored with Bob Collie and Matt Smith, published by John Wiley & Sons, Inc., 2009), my foreword to Someday Rich (by Timothy Noonan and Matt Smith, also published by Wiley, 2012), and my occasional column The Art of Investment in the FT Money supplement of The Financial Times, published in the UK. I am grateful to the other authors and to The Financial Times for permission to use the material here.