Sustainable investment: linking the thinking
Slowly but surely UK corporate pension funds are “linking the thinking” between capital provider and capital recipient and waking up to the potential in SRI (sustainable and responsible investment).
Indeed, corporate pension funds may even prove to be the next big growth driver for a set of investment strategies (SRI) that have defied the recent market downturn and, in its wake, are maturing with a new-found professionalism.
In this article, I plan to discuss the “why?” and the “what next?”
The “why” has three parts: investment performance, strategic rationale and the increased professionalism of SRI.
Investment performance: Recent research by RCM shows how integrating sustainability factors into investment decision-making has no negative impact on performance and may actively enhance it. Henderson Global Investors cite similar findings from their own research and references work by UBS and Macquarie Research. All of these add to the body of evidence collated by Mercer in 2007, which suggests that SRI strategies tend to outperform the market.
However, investment outperformance is not, on its own, enough to convince sceptics. (There is still too much residual prejudice from the days before SRI became an investment strategy – when it was still a moral choice or a campaigning tool). Quantitative evidence needs to be backed up by strategic rationale and robust process. The first of these is clearly visible to all fundamental investors; the second is only known to those inside SRI.
Strategic rationale: Sustainability factors are having an ever-greater effect on the global economy and on capital markets. As evidence, I need only cite the growing impact of climate change, the upwards pressure that population growth and protein demand put on soft commodity prices, the effect of pollution on China’s GDP growth and the continued political scrutiny of all companies’ economic impact.
In this environment, it is just good sense to avoid investment in polluting oil companies and in banks that do not consider their wider economic responsibilities and to invest in companies that capture opportunities in energy-efficiency and pollution control and develop products for the ethical consumer, for the aging consumer and for the “bottom-of-the-pyramid” consumer.
However, much work remains to be done to connect retrospective quantitative evidence and macro sustainability themes with the nuts and bolts of asset allocation, stock recommendations, target prices and portfolio weightings. This is where robust process becomes important.
Robust process: As mentioned above, the SRI industry has weathered the credit crunch well and has grown. It has also invested in developing expertise throughout its value chain. Whereas five years ago SRI capacity largely resided within asset managers and specialist research agencies, it has now permeated into asset owners, investment consultants, investment data providers, sell-side research and other parts of the value chain.
What is more, the industry has diversified to offer a much broader range of strategies (21 at last count) and has developed capabilities in non-equity asset classes (notably bonds, property and, more latterly, infrastructure).
This means that pension fund trustees and other investors can now access, via SRI, strategies for most levels of risk and return expectation.
More importantly, they can evaluate these options with the same level of professional scrutiny that they would use for any other investment strategy that they are offered.
However, I do not believe that either the quantitative evidence, nor the strategic rationale, nor the robust process ‘prove’ the case for SRI; I do not believe that the case will ever be proven; nor do I believe it should be.
The argument for including sustainability factors within investment analysis needs to be fought at every investment morning meeting at every quarterly portfolio review and within every five-yearly pension fund RFP.
As the UKSIF report highlights, the SRI industry is gaining traction and is nicely aligned with a number of major policy initiatives (Kay Review, Stewardship Code, etc.). It stands in direct contrast to those parts of the financial sector that are waiting around for “normal service to be resumed” and for myopic investment models to be re-established that suit some beneficiaries at the expense of the wider economy, society and environment.
In recognition of this dynamism, Thomson Reuters will host a debate in London this Thursday to discuss how SRI will drive forward from its minority (no longer niche!) position into the heart of all investment decision-making.
Thomson Reuters will argue, I expect, that the presentation of environmental and social data within its Datastream product is an important step towards “mainstreaming” SRI research.
Others will argue that the industry needs to invest in its people, to be more aggressive about challenging consensus and to open the market for SRI research to a wider range of participants. I will be arguing that SRI needs to engage more fully the sustainability knowledge and skills of the companies that it invests in by allowing them to Take Control of SRI communications.
This brings me full circle to the unique contribution that trustees of corporate pension funds can make. These trustees have an advantage over their peers from the public or third sectors. They understand the wide range of pressures that businesses have to manage in order to be successful. In many respects, the breadth of vision required by business leaders is exactly the same breadth of vision that SRI investors are introducing to capital markets.
As the UKSIF report demonstrates, there is a way for corporate leaders to “assist and encourage” trustees of the pension plans they sponsor to incorporate sustainability considerations within these plans without breaching the absolutely essential independence of trustees.
Put another way: CEOs often complain that the City is too short-termist and does not consider all of the wider factors relevant to running a company.
In response to this, I now simply ask them one question: Is your own pension fund invested via an SRI strategy or not?