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The Short Guide to Sustainable Investing
By Cary Krosinsky
Do SustainabilityCopyright © 2013 Cary Krosinsky
All rights reserved.
The Challenge of a Sustainable Future
IN MANY WAYS, there's one overriding problem facing us. We can only burn 20% or so of the remaining coal, oil and gas in the ground and stay within some chance of avoiding a catastrophic level of average global temperature increase. This is the science that has settled upon something like a 99% or higher degree of certainty, and it is a loud ticking clock with ever increasing urgency. Yet, as we speak, we largely continue with business as usual, not only in our lives, but with our investment strategies. While awareness is increasing in the wake of Hurricane Sandy and other recent weather extremes, we are at best chipping away at the edges of what we really need to be doing to move to a sustainable society, without which there is arguably no chance for a vibrant economy of any kind.
Investing could be the mechanism that leads us out of this morass, yet most investment strategies either ignore this reality, or take a negative approach to the subject. This book will explore how sustainable investing could become a means of solving a variety of dire, urgent problems, and in a positive way for all stakeholders.
Other trends beyond climate change also stand in the way of sustainable, healthy economies. Recent decades have seen global wealth continue to coalesce at the top, resulting in levels of global inequality that are a severe barrier to economic vitality. I agree with those who suggest that markets need robust quantities of optimistic consumers able to buy robust quantities of goods and services, despite potential environmental constraints to growth as long foretold by the Club of Rome. Further trends in automation provide an additional challenge to anything resembling the sort of growth experienced in the last few generations by Western societies.
Governance is also a vital consideration. Corrupt practices have always been a risk to the well-being of corporate and governmental bodies anywhere in the world, as well as to the communities they serve, reaching all the way back to the first public company, the British East India Company. Yet performance metrics for C-Suite executives almost always do not match the needs of greater society.
With all of these environmental, social and governance (ESG) barriers and risks continuing to emerge as increasingly urgent for society and material for business, can we turn these into positive opportunities? Can investing become part of the answer to the shifting global dynamics we face?
Across ESG factors, it is the environmental reality that is most dire. Drastic action is needed to avoid a variety of future problems, most especially climate change from accumulated greenhouse gas emissions in the atmosphere, and adequate fresh water for increasing global populations. Other environmental challenges from pollution, toxins and other forms of degradation loom growingly critical. Everyone knows the risks we face from our current and future energy consumption trends; the emperor has no clothes, yet no one dares speak of it or act, as the short-term economic implications are significant. Too much is at risk, too many changes are required. Yet change things we must, one way or the other. We seem poised to experience either great calamity from business as usual or radical transformation from current high carbon energy-based economies.
When given a choice of sorts, investors typically stick with the status quo, even in the face of such looming environmental limits and concerns. However, fiduciary duty suggests that asset owners need to act in the best interest of the shareholders they represent; to maximize their returns over time. For example, the California State Teachers Retirement System represents the pension investments of the educators of that state, managed in order to provide maximized paid benefits over the long term to retired teachers both now and in the future in perpetuity. As it turns out, pension funds such as these, along with other classes of shareholder, especially wealthy families and individuals, as well as oil-rich governments and their sovereign wealth funds, own the overwhelming majority of the world's largest companies. Such ownership has become an unwitting enabler of the status quo. Large asset owners often assume, rightly or wrongly, that they need to own the market as a whole, in order to ensure that they are not in violation of their fiduciary duty. What, however, if it is suggested that in the face of future calamity there is a systemic fiduciary duty that all asset owners need to live up to? Would that not suggest a global, coordinated effort to invest in the future we require, and what would that look like? I will explore this further in the Scenarios chapter. The opportunity here is to envision the future we want, the future the world's children require, as Stephen Viederman contends to leave options open for future generations, and to start moving capital accordingly en masse. Without such a vision, we seem headed straight to environmental and economic disaster.
Can we alter asset allocations now, and on a systemic, global, collaborative basis to avoid the various conundrums we face before it is too late, or is the level of existing, well established infrastructure making it such that we need to consider drastic measures such as geoengineering experiments being funded by the likes of Bill Gates?
One way or the other, we would seem well advised to envision a path to global sustainability, and to understand what investing needs to look like in order for it to become part of the future solution. If this sort of approach is indeed required, and if a growing body of investors and asset owners start to recognize this, getting ahead of this trend would be prudent strategic thinking now. One eye at all times needs to be kept firmly on the financial side of the equation – pie-in-the-sky thinking has often led to the formation of bubbles, which then get in the way of necessary progress (capital needs confidence and economic success of its own in order to succeed).
So let us dig in and see how investing could become the answer to what seems like an otherwise intractable systemic problem.
A quick review of the history of what is most commonly called socially responsible investing (SRI) will be a useful place to start – to see what has been tried, and to help encourage the more positive dynamic we now urgently require at scale.CHAPTER 2
A Very Short History of SRI
ONE THING THAT IS PARTICULARLY STRIKING to consider, as we look back through the history of SRI, is how the history of business itself has been taught, or as is most often the case, not taught at all in business schools. It is as if the history of business started after World War I, the last few decades being all that is required to understand efficient market hypotheses and the like. Yet when one goes back a few centuries, what you find instead is the origins of business in the British and Dutch East India Companies. These first global businesses were owned by groups of shareholders in common, creating joint stockholder companies which often experienced wild swings of bubbles, booms and busts. Spend a few minutes and read through the 'History of Slavery' section of Wikipedia, which makes for compelling reading. Slavery goes back as far as recorded history, and directly overlaps the history of global business, with investors gathering to finance trading expeditions to parts of the New World. Moving forward, the late 1800s were also filled with chaotic market stops, starts and panics; history is full of bubble formations, from the Dutch tulip craze right up to what was the recent first wave of cleantech. In his book The Alchemy of Finance (Wiley, 2003), George Soros held that all things eventually seek their true value. I am a firm believer in this. What then do we think will eventually occur to companies with large intangible risks hidden within today's so-called externalities? Although markets have found a way to ignore many environmental externalities over recent years, can fund managers and asset owners exit in time from onerous sectors that become suddenly uncompetitive due to market forces and potential changes in collective global awareness? Coal companies are recently experiencing this phenomenon, trading way below price peaks from just a few years ago, as cost curves shift and coal use becomes an increasing health concern on the ground. Environmental externalities becoming internalized is a new risk that investors now face. There is a long history of academic literature demonstrating that it is not possible to time markets, so when to get out of environmentally risky sectors and companies becomes a pressing issue worth serious consideration. The same is increasingly true of social issues as well, with capital favoring companies that solve problems rather than causing or intensifying them.
From SRI to sustainable investing
SRI has its roots in divesting from South Africa in the 1970s and 1980s. This was an important first success for the field, with SRI getting proper credit for helping contribute to the societal changes that occurred as the country moved away from Apartheid. This perhaps helps explain why the first wave SRI community in the US has remained primarily rooted in engagement and advocacy as strategies for change. Globally, religious mandates over time also account for the development of SRI to what it is today.
I have urged elsewhere that we reject the phrase 'socially responsible investing' as too broad. SRI is alternatively known as responsible investing, ethical investing, sustainable investing, impact investing and more. It can encompass everything from investments in alternative energy to funds with a religious mandate to portfolios that seek to get in front of innovation megatrends among so-called 'large caps' (the largest public companies). SRI also can involve advocacy and engagement. There is also the exciting field of impact investing, which in turn can include areas such as microfinance and community investing. There are also regional differences that manifest, and perhaps most importantly, differences in performance once you parse out these strategies.
This all reflects the ongoing terminology war that continues unabated in this field, which might seem hopelessly confusing. However, it is actually quite easy to parse through this noise. What Nick Robins and I called 'sustainable investing' has both a risk and opportunity side, but needs to be executed in a positive manner for best effect, as we found in a previous book on the subject. At the time, we looked at all of the world's 850 publicly facing socially responsible, ethical, sustainable, etc. funds, and divided them between those primarily positively focused and those negatively focused. Positively focused funds outperformed the mainstream and their negative counterparts over the one-, three- and five-year periods that ended in December 2007. In a follow-up book we parsed through the many SRI studies that have been performed, and found when assigning these same negative and positive aspects that positive approach-based studies showed outperformance, while those studies that found otherwise were focused on negative aspects. Deutsche Bank's 2012 study (https://www.dbadvisors.eom/content/_media/Sustainable_Investing_2012.pdf)
on sustainable investing found the same, inferring that any issues in performance were due to negative approaches. Yet, the majority of SRI assets remain deployed pessimistically, a legacy of the history of the field and proof of just how sticky assets and strategies are, even in the face of looming change. We also found that better SRI fund performance directly correlated with lower turnover (in the sense of lowest frequency of buying/selling shares), meaning that those that did their homework well and stuck to their guns, ended up the winners. This sounds more than a little like Warren Buffett, and in fact a buy and hold strategy is what passive investors seek as well – low cost ownership over the long term – and so what seems most sensible to consider is finding low transaction cost investment solutions that best ride out the sustainability transition that we anticipate will only continue to grow. Excitingly, Jacques Lussier, former Chief Investment Strategist for Desjardins in Montreal, finds recently that successful investing is a process that can be enhanced by sustainable investing practices. Even if sustainable investing does not offer 'alpha' (outperformance against benchmarks), if the practice does not take away from portfolio performance, then given long-term systemic fiduciary responsibilities there is no excuse for large asset owners not to participate.CHAPTER 3
Best Practices in Sustainable Investing
IF QUALITY SUSTAINABLE INVESTING does not take away from performance, while offering a chance for alpha, a quick review of some of the better practices on offer is called for. In the UK, and Europe more broadly, more sophisticated strategies continue to emerge that attempt to address macro-issues of sustainability as categories of opportunity. European investors have long been ahead of this game, and corporates are starting to see that if they drive sustainability a growing base of investors will be interested in riding this wave, in effect creating the sort of positive dynamic we seek.
Some of the most successful strategies in this regard range from the Jupiter Ecology Fund to the UK's Generation Investment Management, the latter managing over US$6B, and has found outperformance over time through a combination of business and management quality as overseen by Al Gore and David Blood.
I highly recommend you seek out the Harvard Business School case study on Generation Investment Management, which remains seminal. It lays out the investment methodology they pursue, seeking to evaluate companies on the basis of both BQ (business quality) and MG (management quality) with an underlying environmental and social sustainability theme. In effect, Generation Investment Management seeks and has largely found outperformance through identifying a small number of 'winners of tomorrow' with a sustainability lens, through factors that include market position, ability to execute and those that can solve societal problems. In fact, Generation Investment Management's performance would be even better if not for Al Gore's board positions at Apple and Google, which due to conflict of interest they do not invest in, thus preventing them from being owners in two of the best performers from a sustainability perspective. At any rate, Generation Investment Management's performance has been stellar, and they stand as an example of how to invest in a forward-looking sustainable manner.
The Jupiter Ecology Fund may be the longest standing example of what we talk about as future focused sustainable investing. The fund has a clear remit to find companies best positioned to solve environmental and social problems, and has had very low turnover of investment personnel over time as well. While struggling after the financial crisis, the fund remains ahead of both its sector and benchmark over the past 10 years, and has had a very consistent focus. For example, one of the top holdings of the fund for this 10-year period has been Cranswick plc, a provider of organic pork products. Other companies in the top 10 include Stantec (water solutions and more) and East Japan Railway, and although a UK-based fund, Jupiter Ecology has over 40% of its investment in North America.
While both Generation Investment Management and Jupiter Ecology are UK-based and longstanding examples of SRI funds seeking positive solutions with success over time, SRI strategies that seek outperformance through opportunity are less prevalent in the US, where approaches remain largely focused on engagement and negative screening. There are a handful of exceptions and they are worth noting.
Seeking outperformance through opportunity
Parnassus Investments based in San Francisco has been the most rapidly growing SRI fund manager in the US, growing from US$1B to 6B in assets under management in recent years, largely by taking a relatively sophisticated approach to seeking value through ESG factors. Parnassus Equity & Income Fund is the largest publicly traded SRI fund in the US as of the end of 2012, and is well over benchmark for the last five years: +5.16% versus +1.34%. This fund has been the fastest growing SRI fund over the previous five years, which was quite a volatile period for markets, demonstrating the resilience of this approach. Examples of some of their largest investments include a variety of companies looking to capitalize on sustainability as an ongoing business opportunity, including largest holding Procter & Gamble, who famously pinpointed water heating for laundry as the largest component of their ecological footprint, and targeted it with cold water laundering solutions. Other key investments include Waste Management and Google, both among companies taking sustainability opportunities very seriously.
Excerpted from The Short Guide to Sustainable Investing by Cary Krosinsky. Copyright © 2013 Cary Krosinsky. Excerpted by permission of Do Sustainability.
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