When David Blood co-founded Generation Investment Management in early 2004, his goals were broader than might be expected for someone in his position. For the former CEO of Goldman Sachs Asset Management and his partner in the venture, ex–U.S. vice president Al Gore, the overarching challenge would be proving the viability of a new type of capitalism in which sustainability factors are as baked into business and investment processes as are hard financial data.
Blood says London-based Generation, which now manages $12 billion in assets, has never wavered from its commitment to three principles: managing risks, paying attention to resource use and constraints and investing in products and services that address long-term sustainability challenges. But one thing has changed: “What’s new is, we have a ten-year track record,” notes Blood, 56, a Pittsburgh native who has lived in London for 22 years and holds an MBA from Harvard Business School.
The largest of Generation’s three strategies is global equity. Established in 2005, it’s a concentrated portfolio of 30 to 60 public companies. A second strategy, launched in 2008, focuses on growth-stage private and public businesses that have a role in the transition to a low-carbon economy, with an emphasis on Europe and North America. Finally, Generation’s credit business has invested in small and medium-size companies since 2013.
Over the past 18 to 24 months, Blood and his colleagues have had about ten conversations with large institutional investors that weren’t clients and came to the firm with questions about the role sustainability should play in their portfolios. In February he and Gore visited the investment committee meeting of the $191 billion California State Teachers’ Retirement System — itself no stranger to such themes — to present an educational session on sustainable investing.
The investment committee asked about the risks that carbon exposure could pose to the public pension fund’s portfolio. Along with a growing number of other institutional investors, West Sacramento–based CalSTRS has voiced concerns about the energy industry’s potential problem of stranded assets — energy reserves whose value could plummet as governments tighten regulation to combat global warming. Legislation that would require CalSTRS and the $293 billion California Public Employees’ Retirement System to shed their fossil fuel holdings is pending in California.
Contributing Writer Katie Gilbert recently asked Blood what advice he has for funds that are considering fossil fuel divestment and how sustainable investing has evolved over the past decade. The Generation co-founder also shared his views on what’s wrong with capitalism — and whether it can be fixed.
Institutional Investor: Has sustainable investing gained wider acceptance among institutional investors since you co-founded Generation?
Oh, yes. One of the things that’s changed over the past five to ten years is that the business case for sustainable investing and sustainable business is much more robust. There’s much more evidence around it, there’s been much more thoughtful academic work, and there’s been more analysis of the benefit of using sustainability as an investment tool. I wouldn’t pretend that sustainable investing is mainstream today, but I will say that the difference between today and five years ago, and certainly ten years ago, is night and day.
What’s driving this conversation is the only thing that can drive it: the business case. Does this allow you to be a better investor or run a better business? The academic and practical evidence is yes, it does enhance your business, and yes, it does enhance your investment portfolio. This would not gain momentum, nor would it be anything more than a niche, if it were only about values. It’s not.
Have companies evolved their thinking about sustainability?
Absolutely. They’ve continued to evolve their business strategies around sustainability, even if they don’t call it sustainability, because they recognize it’s the best way to build their businesses. I would tell you that companies are ahead of investors in this regard.
What they’re asking themselves is, How do you build great long-term businesses? That’s what is getting greater focus today than a few years ago.
Why is sustainable investing so much more readily accepted, and seemingly farther along, in Europe than in the U.S.?
I don’t know for sure. But I’m betting it’s this: In Europe sustainability has been more a way of life. It’s not political.
In the U.S., unfortunately, sustainability started out as more politically based. That’s why fossil fuel divestment is still such a lightning rod. And in the U.S. sustainability doesn’t tend to be viewed as a particularly rigorous tool. It tends to be perceived as tool from the left. On that basis, many people dismiss it out of hand.
What advice can you offer institutional investors on fossil fuel divestment? How do you feel about the pending legislation in some U.S. states that would require public funds to divest?
Both Al [Gore] and I have signed the individual pledge to divest from fossil fuels, though of course we had already done so. That decision, as individuals, is one we’d say was a moral decision. We don’t feel we should own fossil fuels, and similarly many investors feel they should divest for moral reasons.
The investment case is different. We strongly believe that it is the fiduciary duty of all investors to understand the risks and opportunities in their portfolios, and as it turns out, carbon is a risk and opportunity that should be very well understood.
Fiduciary duty is often invoked to make the opposite point, that funds should not divest from fossil fuels.
We disagree. As a fiduciary it is in your long-term interest to understand what your carbon exposure is across all asset classes. This might lead you to conclude that divestment is the proper course of action. You should also think about what you mean by engagement. You need to define whether engagement is about information gathering or changing companies.
If you think it’s about changing companies, you need to think very realistically about whether you are going to change an organization. I think it’s fair to say that with some companies, you can engage with them, but they’re not going to change.
Nobody — no pension fund, no endowment — can say, “Well, we shouldn’t divest because we’ll lose our engagement opportunities, and we’ll lose our ability to generate returns.” We need a much more nuanced approach and response.
How can investors best rebalance risk and protect against blows to performance if they do get out of fossil fuels?
The questions you have to ask yourself are, What is our hydrocarbon exposure, and what percentage of our opportunity set are we giving up?
In the case of coal and tar sands, it’s a really small number. No long-term asset owner should own coal or tar sands investments. In our view, the risk-return spectrum of those assets is not good at all. You’re not losing anything by not having those businesses in your portfolio or in your indexes.
You could come up with a program that reflects the [energy] transition we’re making. If you are a passive manager or passive investor, you could create an index that has a smaller carbon exposure. If you are an active owner, you can look at your portfolio and say, “What other types of assets might reflect the price of energy?”
At Generation we haven’t owned a hydrocarbon in our portfolio for a long time. You don’t have to own energy stocks to outperform. There’s no rule that says you have to do that, and there’s no rule that says you can’t build a very robust and interesting return-versus-risk portfolio with a lower-carbon intensity.
You recently said, “We think capitalism is in danger of falling apart.” What do you mean, and what’s the best way for an investor like yourself to respond to that threat?
First, I think all of us in finance need to be aware that our license to operate is imperiled. All of us — pension fund managers, investment managers, et cetera — need to be very aware that many of our fellow citizens are wondering whether we’re providing value to society. Fair enough. We’ve just gone through a terrible financial crisis, we’ve gone through scandal after scandal, incentive structures seem to be misaligned.
The second thing is that capitalism itself is imperiled because many people are beginning to believe that capitalism isn’t serving broader society or markets, that it seems to be serving a small number of people.
Some, like Naomi Klein in her book This Changes Everything, suggest that the way to solve climate change is to change capitalism out for some other system. I understand how she can get to that point of view, but I don’t think it’s right, because we don’t have the time or an alternative to the current system.
When we founded Generation 11 years ago, we felt that the world faced dramatic challenges — poverty, water, climate change, health, demographics, just to name a few. These are all interrelated, and they’re getting more acute. It’s clear that the world doesn’t have enough philanthropy to deal with them, and governments don’t have enough capital to deal with them. The only way we’re going to collectively address them is if we mobilize business and capital.
I think, ultimately, finance and capitalism can be a force for good. People can say that’s naive or self-important. I don’t think so. This is a tool that we know how to deploy. We just need to fix the tool a little bit. And if we deploy it well, I think we can have a good outcome.