We learned back in October that companies that adopt ESG policies in their day-to-day operations enjoy both market- and accounting-based outperformance over the medium to long term. This was big news, so let me explain it as clearly as I can... ESG isn’t just for hippies anymore; extra-financial variables are legit and have to be taken seriously by institutional investors, especially when considering long-term investment strategies.
So, for the champions of ESG, it's mission accomplished, right? High fives all around? Why, all that’s left to do now is simply change the way the broad community of institutional investors – the public pensions, sovereign wealth funds, endowments, etc. – make their investment decisions. That should be relatively easy, right? Wrong.
Anybody who’s spent much time working with these Giants knows that innovation and change do not come easily to this crew. And so the good folks that lead the ESG movement will still have plenty of work to do before these long-term factors play a role in their day-to-day functioning.
This fact is not lost on the people in charge of the UN’s Principles for Responsible Investment, which is why the PRI is already planning its next set of policy initiatives. In fact, PRI just released a new “consultation” document that suggests its top priority will be on the ‘top-down’ barriers to a sustainable financial system. Here’s a blurb:
“Responsible investment practitioners know from direct experience that short-termism, misaligned incentives in the investment chain, environmental and social externalities, instability in the financial market as a whole and a range of other factors can impede their efforts to integrate ESG issues into investment decisions and to make capital markets more sustainable overall. Some of these are addressed by the PRI Initiative’s existing work. Many are not... This new action-oriented work stream will bring together groups of signatories to develop practical ways for investors to change their own practices in order to address these challenges, and proposals for any necessary changes to public policy.”
In other words, in order to enjoy the long-term performance benefits of ESG, institutional investors have to have the capability to first include ESG factors in investment decision-making. And this will mean that they have to be able to take a long-term investment perspective; that they have to be able to execute these strategies in-house or work creatively with external managers. And, as the PRI now recognizes, many institutional investors do not have that capability, and the PRI wants to change that. Here’s another blurb:
“There are barriers found in current market practices, structures and regulation that undermine the interests of investors and the systems within which they operate. These factors, which include significant dimensions of the behaviour of both asset owners and investment managers, impede the integration of ESG considerations into investment processes and ownership practices, and in most cases they are not addressed directly by PRI’s current work.”
True. So what’s the PRI going to do about it? Well, it hopes to...
“...develop new approaches to designing investment mandates, including benchmarks, performance periods, portfolio turnover and fee structures... [and] at a higher level than the structure of individual mandates, decisions about portfolio structure and strategic asset allocation set the framework for all other investment decisions. The financial crisis has sparked profound questioning of traditional approaches based on modern portfolio theory and diversification.”
In short, PRI appears to be interested in improving the operations of institutional investors. They (rightly) see that one of the biggest impediments to “long-term, sustainable investment” is the institutional investors' own inadequate capabilities. And so they're joining the fight to improve the operations of these funds. I’m very pleased to have them on the team.