Sustainable Investing: The Art of Long-Term Performance, a collection of articles from 22 contributors including co-editors Cary Krosinsky and Nick Robins, was released in the fall of 2008. SI challenges investors to look beyond what contributor Steven Lydenberg calls "the fast-paced speculative nature of today's financial markets." Socially responsible investors (SRI) have been striving to meet this challenge for decades, and now current events have exposed the financial system's myopia as an urgent global crisis.
If it had been released last year, this book would have been a valuable primer on how some investors integrate environmental, social and governance (ESG) factors into their strategies. In the winter of 2009, however, Sustainable Investing now offers answers to questions the whole world is asking. Consider this diagnosis from a January 3 New York Times article by Michael Lewis and David Einhorn:
"Our financial catastrophe, like Bernard Madoff's pyramid scheme, required all sorts of important, plugged-in people to sacrifice our collective long-term interests for short-term gain. The pressure to do this in today's financial markets is immense. Obviously the greater the market pressure to excel in the short term, the greater the need for pressure from outside the market to consider the longer term. But that's the problem: there is no longer any serious pressure from outside the market." [Emphasis added]
Outside the Market, Inside the Real Economy
Mr. Krosinsky and Mr. Robins, their authors, and the SRI/sustainable investment sector worldwide could reply: We are the pressure from outside the market.
"Outside the market" is the real economy of workers, customers, communities and the natural environment. Sustainable investors balance the short-term demands of capital markets with the long-term needs of society itself.
Cary Krosinsky is vice president at Trucost PLC, and Nick Robins is head of the HSBC Climate Change Centre of Excellence. The editors and their contributors are industry insiders, but their view beyond quarterly returns, and beyond those Warren Buffett called "geeks bearing formulas" – reintroduces "outside" global concerns to finance. (For more about the editors, see the end of this article.)
What Share Prices Don't Tell Us
Defenders of the "efficiency" of modern capital markets might argue that the information embedded in a share price tells the outside world all it should know about a stock, or a company. In "The Emergence of Sustainable Investing," Nick Robins presents statistics that say otherwise.
In 1986, investors held a London Stock Exchange-listed share for an average of nine years. In 2006, the average stock was held for only eleven months. How much can a share price convey about a corporation's long-term value when stockholders, as Mr. Robins writes, "cannot wait between one annual report and another before trading"?
Another number offers a clue about who really benefits from the computerized churning of modern capital markets. In 1981, the US finance sector earned 14% of total corporate profits. In 2001, its share had grown to 39%. "A growing share of global output is taken by the finance sector and its employees," Mr. Robins notes.
SI contributor Steve Waygood, in his article "Civil Society and Capital Markets," acknowledges that markets "hold the scorecard, allocate and price capital, and provide risk coverage and price risks." Unfortunately, he argues, their "current structure undermines long-term sustainable development goals."
Sustainable Investing argues that the inequities generated by a myopic, ever-expanding finance sector are not only unfair – they're unsustainable. SI's contributors explain why, and they also outline a model for the integration of ESG factors into investment decisions.
How Sustainable Investors Help Prices Tell the Truth
When investors incorporate ESG factors into their analyses, they introduce new information into capital markets. Corporate environmental practices (such as energy consumption or carbon emissions), social policies (including employee benefits and customer relations) and governance (such as executive pay and responsiveness to shareholders) may be "outside the market" concerns, but they matter to governments, investors and ordinary citizens.
"SRI is a form of consumerism, which resonates with global common values that anywhere from 5 to 20 percent of every nation cares about," explains Tessa Tennant in "The Global Agenda." Such percentages may not add up to a political majority, but they do represent millions of people and billions of dollars of investment, labor and consumption.
Investment analysis cannot afford to ignore these global common values. Such ignorance distorts capital markets and may be a risk to the market system itself. To dramatize this risk, Nick Robins quotes Ernst Von Weizsacker: "The system of bureaucratic socialism can be said to have collapsed because it did not allow prices to tell the economic truth."
Prices in a capitalist system may also obscure the truth, if buyers or sellers neglect to measure and disclose relevant information. ESG factors represent relevant risks and opportunities for corporations, and quarterly statements and share prices may not account for these risks. For example, over the past three years, some US utilities with otherwise strong financials have been forced to cancel new coal-fired power plants. These setbacks – driven by political concern about carbon emissions, which is a key ESG metric – demonstrate the market risk of external societal forces.
Sustainable investors help equity markets tell the economic, political and ecological truth.
Sustainable Investing: Two Conflicts in Focus
SI is organized into four distinct sections. Parts I and II present the past and present of sustainable investing, and Part IV considers future trends. Part III is an intriguing look at asset classes beyond the publicly-traded equity markets. Each section could be the subject of its own review, but SI's treatment of two particular sources of tension is especially relevant to the current economic situation.
First, SI's authors, especially Cary Krosinsky and Julie Fox Gorte, distinguish between "socially responsible" and "sustainable" investing. Their work suggests that while both approaches rely on the sort of ESG research that KLD (and Trucost) provide, sustainable investors may use somewhat different methods than traditional SRI investors.
Second, SI considers the global forces that promote sustainable investing, and also the persistent obstacles to its broader mainstream acceptance. While public concern about issues like climate change has made sustainability a buzzword, Steve Lydenberg (among other contributors) finds reason to "wonder how real these changes are, how deep their roots."
SI complements high-level macroeconomic thinking with pragmatism. For example, contributors Valery Lucas-Leclin and Sarbjit Nahal, in "Sustainability Analysis," tackle the practical problem of creating price signals to incorporate ESG factors into mainstream quantitative analysis. Other contributors also consider integration's impact on real-world problems and processes.
Mr. Krosinsky and Mr. Robins conclude their book with a qualified endorsement of sustainable investing's – and the economy's – future.
On the Sustainable and the Socially Responsible
When mainstream academics and journalists consider ESG investing, they typically ask a variation on one simple question: "Will it hurt returns?" Some observers are certain that it will, while other studies have found that investment returns may even benefit from ESG integration. Cary Krosinsky – both in his GreenBiz blog and his contributions to SI – emphatically promotes sustainable investing as a "market-beating strategy."
In "Investors: A Force for Sustainability," Julie Fox Gorte argues that sustainable investing can outperform the market through "fidelity to long-term drivers of…superior sustainability." She writes:
"…Sustainable investing is defined positively by seeking to invest in companies whose practices and policies include sustainability goals, where classic SRI was often defined negatively by what industries or companies were excluded."
Long-time practitioners of SRI could argue that exclusions of cigarette manufacturers, for example, also serve the goal of sustainability. From this perspective, smoking's externalized costs to society, when considered over a longer time horizon, would outweigh any short-term financial returns.
In their introduction, the editors help explain why they believe that any tension between these perspectives is outweighed by their shared priorities:
"Sustainable investing…provides an agenda for action for purely financially motivated investors eager to mitigate risk and benefit from upside opportunities, as well as for civil society organizations [or individuals] aiming to achieve social and environmental progress."
Sustainable Investing's Growth Drivers
SI's authors are an impressively multinational group, and their breadth of perspective reinforces the sense of global momentum for ESG integration. They consider sustainable investing's growth drivers in depth:
Political and Regulatory Pressure – Abyd Karmali, in "Observations from the Carbon Emissions Markets," studies the European Union's carbon-credit trading scheme, and in "Carbon Exposure," Matthias Kopp and Bjorn Tore Urdal model the future impact of emissions reduction regulations on German utilities. Both analyses offer insight on how global business could respond to public impetus for a more sustainable economy.
New Asset Classes – In "Fixed Income and Microfinance," Ivo Knopfel and Gordon Hagart describe how institutional investors' increased appetite for bonds – combined with public pressure on investors like colleges and governments to invest sustainably – will shape the strategies of fixed-income managers worldwide. Other Part III articles consider sustainable property investing, "social businesses" and private equity investment. The private equity article, by Ritu Kumar, illustrates the potential for this sector with case studies of firms that already focus on clean tech, clean energy and emerging markets.
New Markets – China and India, as emerging economic superpowers, each merit articles in SI's section on future trends. Ray Cheung explains how the environmental impact of China's rapid growth has finally drawn a government response. He focuses on the huge potential that new Chinese regulations offer for clean tech suppliers and investors. India faces similar ESG problems – including not only labor and environmental concerns but also relationships with regimes that violate human rights, such as Burma and Sudan. As Dan Siddy describes in his piece on India, these issues may not have concerned investors in the past, but they will in the future:
"ESG problems related to Indian, Chinese, and other emerging-market companies are likely to become more frequent, more acute, more visible and more frequently associated with shareholder value destruction."
Obstacles to Sustainable Investing's Growth
Overall, SI makes the case that sustainable investing can, and should, redefine the practice of investment itself. As the editors write in their conclusion, "The challenge…is not to become like today's mainstream, but, rather, to replace it." But to the credit of the editors and their contributors, SI also describes the ongoing resistance to ESG integration.
Political and Regulatory Pressure – The same force that encourages better Chinese environmental practices – the power of an authoritarian government – is also a threat to the human rights that are of equal importance to traditional social investors. Ray Cheung explains:
"…[As] with everything in China, the buyer must beware. … Given the country's one-party political system, Chinese and international firms must be willing to make dubious compromises with authorities; for example, Google censored a local Chinese search engine, and Yahoo! turned over to police email records of a Chinese journalist, leading to his arrest."
This case may seem unique to China, but political considerations may inhibit sustainable investment in democracies, as well. Even regimes that support better environmental practices are subject to pressure from political blocs, such as fossil fuel producers, who support the status quo. As a result, the case for sustainable investing depends on political action from individuals and interest groups.
In "Civil Society and Capital Markets," Steve Waygood explains how non-government organizations (NGOs) play an important role in both mobilizing political pressure and helping companies implement divestiture campaigns and other initiatives. However, he writes, "To date, capital market campaigning has mainly targeted investors as a way of influencing corporations rather than attempting to change the structure of the capital market itself."
This may be changing. Government complicity in the current banking crisis – or, at least, the public perception of such complicity – has already motivated some sustainable investors to direct more effort towards regulatory reform.
Limited Thinking – Since sustainable/SRI investing first emerged, its skeptics have questioned its value. Nick Robins sums up the stock objection from adherents of "conventional financial theory":
"The assumption is that the introduction of non-financial factors will harm diversification and thereby incur penalties in terms of risk returns."
Mr. Robins explains that while not every ESG factor has an immediate impact on a company's bottom line, "investments selected on the basis of identifiable ESG factors…do tend to outperform." Each of SI's contributors presents evidence of the opportunities represented by ESG integration, or of the risks of neglecting these factors.
Still, conventional wisdom persists. Stephen Viederman confronts a still-strong redoubt of anti-SRI bias in "Fiduciary Duty." He cites the example of ExxonMobil, which acknowledges the reality of climate change but "refused to respond to a shareholder proxy resolution asking the company to 'adopt a policy on renewable energy research, development and sourcing.'"
How should investors – especially trustees who are bound by fiduciary obligations – respond to this recalcitrance? "Conventional financial theory" would suggest that a trustee who sold ExxonMobil stock because it wasn't prepared for climate change has violated his fiduciary duty. After all, the company's share price is steady and its record of dividends is strong.
Mr. Viederman proposes a contrary understanding of fiduciary duty. He asks:
"Although highly profitable now, are ExxonMobil's profits going to be sustainable, and is ExxonMobil in its pursuit of profit now limiting options for future generations?"
Until a critical mass of investors agrees with Mr. Viederman – that "advancing social, environmental, and financial benefits is the new fiduciary duty" – then their limited thinking will continue to limit the growth of sustainable investing.
Limited Resources – This obstacle to sustainable investing is rooted in a concept that its adherents are already familiar with: wealth, both human and natural, is finite. Most of SI's contributors convey at least some optimism about humanity's future, but Julie Fox Gorte concludes her piece by sizing up the task ahead of us.
"In order to stabilize the climate…emissions must be reduced 70 per cent below the levels of 1990 – a profoundly greater step than the 5 to 8 percent reductions called for [by]…the first Kyoto Protocol."
What tools can we use to accomplish this task? Ms. Gorte presents the conundrum of an extractive, industrial, corporate civilization choosing, perhaps, to stifle the source of its power. Hers is a sobering but necessary perspective:
"…For decades, the average profit margin in the US hovered around 8 percent. The simple arithmetic of this is that the amount corporations and investors have to spend on saving the planet is less than 10 per cent of what they spend to get that power, which is largely responsible for creating the problems in the first place. …We are accustomed to thinking…that our transformations…make things better for us. But we are at the threshold of a transformation that makes things profoundly worse, at least for the two or three generations whose faces we will see during our allotted spans."
Conclusion: The Sustainability Moment
In the face of such an awesome task, Sustainable Investing's editors and contributors offer no easy answers. Instead, they describe the steps that have been made towards a sustainable economy, propose further steps, and perhaps most importantly, they confront the objections of a still-skeptical world.
Mr. Krosinsky and Mr. Robins conclude by acknowledging that the recession has "put sustainability concerns on the back burner" for many leaders, citizens and investors. They describe this mentality as one that sees sustainable investing as a fad, as "merely a cyclical bull market phenomenon." Sustainable Investing is a thorough, much-needed refutation of this mistaken belief.
As the editors explain:
"This [belief that sustainability is a fad], however, is not just a misreading of history, but a strategic misinterpretation of the structural, secular nature of the sustainable investing phenomenon. ... Not only is the investor case [now] much better understood and embedded among the world's leading institutions, but sustainable investing strategies are increasingly seen as essential to the recovery itself."
As the UN proposes a "Green New Deal," and old economic assumptions fade throughout the world, this could be the moment when the mainstream becomes sustainable.
About the Editors:
Cary Krosinsky joined Trucost as Vice President in 2008 to help represent Trucost in North America. He was previously a member of CapitalBridge's Operations Committee, providing leadership on data and analytics. He maintained many of the largest banking and corporate relationships for the company in the US, Europe and Asia. He has also been a member of the 70 person Expert Group that led the creation of the United Nations Principles for Responsible Investment (PRI).
Nick Robins is head of the HSBC Climate Change Centre of Excellence. He has 20 years experience of promoting sustainability in business practice, financial markets and public policy. He joined HSBC in October 2007 from Henderson Global Investors, where he was Head of SRI Funds. During his time at Henderson, he helped to design and launch its pioneering "Industries for the Future" fund, and is a member of the UK Government's Sustainable Development Panel.