Sustainable investing builds greater long-term value for companies, industries and society. Each of the speakers and panels at our November 19th seminar on “Mainstreaming Sustainable Investing” spoke to that theme. They cited the growing evidence, from both academic research and market participants, that companies incorporating ESG considerations experience reduced risk and create greater long-term value.
The strength of those arguments was evident in the questions that followed. The discussion was not whether sustainable investment made sense, but how to do it in an investment environment where so many are focused only on the short term – today’s stock price, next quarter’s earnings.
Addressing that challenge requires multiple strategies, some of which were part of the day’s conversation:
- Rob Lake pointed out the importance of active ownership – engaging with companies to create long-term value and avoid risk.
- Cheryl Smith and Tim Brennan provided examples of successful engagement during the panel on fossil fuels.
- Erika Karp highlighted the importance of incentives and the development of new business models in the financial sector.
- Erika also cited global trends supporting this movement – a grass roots demand for a more long-term oriented capitalism and the transfer of wealth to a younger generation that is “more conscious, more demanding, more interested in societal impact, and more unwilling to give up competitive returns to get that impact.
- Steve Lydenberg traced the growing movement for greater sustainability disclosure, the increased availability of metrics, standards and key performance indicators; and the trend toward greater integration of that information by corporations and investors.
But challenging the short-term mindset is not just a job for sustainable investors. In fact, there is a growing consensus that this short-term focus is harming the recovery and future growth of the economy and is undermining confidence in the global financial system. So perhaps we should turn this question inside out. Instead of convincing investors to take a longer-term perspective so that they can become sustainable investors, perhaps the argument should be that they can become better long-term investors by being sustainable investors?
The case for focusing capital on the long term was recently laid out clearly and emphatically in a Harvard Business Review article (Jan/Feb 2014) [1] by Dominic Barton, Global Managing Director of McKinsey & Company and Mark Wiseman, President & CEO of the Canadian Public Pension Investment Board. (Eric Wetlaufer of the CPPIB presented at our November seminar.)
The authors highlighted the scope of the problem by citing their 2013 survey of 1,000 board members and executives which found that:
- 79% feel “especially pressured” to deliver strong financial performance over two years or less
- 86% believe that using a longer horizon would “positively affect corporate performance”, including “strengthening financial returns and increasing innovation”.
The largest asset owners – pension funds, insurance firms, mutual funds, sovereign wealth funds – are best positioned to push for a more long-term approach from companies and should be motivated to do so. They own 73% of the top 1,000 US companies. They are fiduciaries for long-term investors and have liabilities that can extend to multiple generations.
But, the authors argue, these large asset owners are in fact not engaging with public companies on long term strategy and are using “benchmark-hugging short term strategies” themselves. In short, they aren’t acting like owners. A comparison done by the Canadian Pension Plan Investment board showed a 1.5 – 2.0% annual outperformance by privately-held companies over comparable public companies, after accounting for differences in leverage and the substantial fees paid to private equity firms.
This and other research convinces the authors that the consequences of this behavior are stark:
Simply put, short-termism is undermining the ability of companies to invest and grow, and those missed investments, in turn, have far-reaching consequences, including slower GDP growth, higher unemployment and lower return on investment for savers.
The authors propose four approaches to help focus more capital on the long term. Though directed at the governance and operations of large asset owners, much of what they advocate will be readily recognizable to sustainable investors.
- Define long-term objectives and risk appetite, then invest accordingly
- Set a multi-year time horizon for value creation.
- Define acceptable risk over the entire time horizon and accept some short-term underperformance.
- Companies with long-term “intrinsic value” and illiquid assets like real estate may be a bigger part of the portfolio.
- Unlock value through engagement and active ownership
- A core element of sustainable investing. But the authors point out that engagement can (and should) be executed at different scale and intensity depending on the level of ownership and the resources available to the investor, and that investors can collaborate to extend their reach.
- Demand long-term metrics from companies to change the investor-management conversation
- ESG indicators and metrics are among those most closely tied to long-term value creation.
- Working with organizations like SASB (Sustainability Accounting Standards Board), IIRC (International Integrated Reporting Council) and others can guide the selection and communication of the performance indicators most relevant to a company or industry.
- Information providers (MSCI, Bloomberg, Thomson Reuters and others) have made long-term metrics much more widely available.
- Structure institutional governance to support a long-term approach
- “Proper corporate governance is the critical enabler”
- “their primary fiduciary duty is to use professional investing skill to deliver strong returns for beneficiaries over the long term – rather than to compete in horse races judged on short-term performance”
Sustainable investors should be participating in this wider conversation about long-term investing – not just with companies they invest in, but with the firms that manage their investments.
References:
- ↑ Read the full article in the Harvard Business Review (subscription required).