In this summary of a book chapter, James Gifford, the founding Executive Director (2006-2013) of the Principles for Responsible Investment (PRI), explores whether, 10 years on, the vision of mobilising asset owners around responsible investment is being achieved.
He also looks to the future of responsible investment, and the role asset owners might play in bringing about further positive change. Gifford says the first era of responsible investment, pre-2004, was primarily about values-oriented and retail-focused socially responsible investment (SRI). The second era, 2004-2014, was the environmental, social and governance (ESG) era, where these issues went from being treated as irrelevant by investors to being treated as potentially material and incorporated into mainstream investment practices. This era also brought shareholder dialogue on ESG issues into the mainstream.
James Gifford, Senior Research Fellow at the Initiative for Responsible Investment, Harvard Kennedy School. The Changing Role of Asset Owners in Responsible Investment: Reflections on the Principles for Responsible Investment – the last decade and the next
The next 10 years, Gifford says, will see yet another transition, where investors will be held more accountable for their impact on the world, in the same way that the largest corporations (sometimes) are. Here are six responsibilities that Gifford believes asset owners need to improve upon over the next decade:
1. Reduce externalities
Gifford believes asset owners should push for policies and frameworks that reduce the negative consequences of their actions: pushing investee companies to set minimum standards and certifications, and supporting public policy that would result in the most efficient allocation of environmental and social resources (e.g. pollution control, emissions trading schemes).
2. Align time horizons
Pension funds often have investment horizons of many decades, while most people who directly manage this pension capital are incentivised to outperform in a year or less. As a consequence, Gifford suggests there should be a greater responsibility to ensure time horizons are aligned with investment horizons, and matched more closely with the actual liabilities of long-term asset owners. The author says this would allow greater investment in less liquid asset classes, particularly those that would help to build a low-carbon future.
3. Select suitable investment managers and monitor them
The author notes that the majority of asset owners outsource most, if not all, of their investment management to external investment managers. Therefore, the most important role of a responsible asset owner is to select and monitor the right managers. While this was included as a possible action of Principle 4, and progress has been made, Gifford believes there is still a long way to go. The author says the first step is to put questions and expectations about responsible investment capability into requests for proposals that go out to investment managers, the implication being that unless you are doing something on responsible investment you will miss out on investment mandates.
The next step is to ensure that managers actually implement their responsible investment policies and report on their achievements, goals and challenges in the same way they report on their financial performance. Even for those asset owners that do set long-term, sustainable investment mandates, these intentions can quickly be undone by sending mixed signals in terms of what is important. Gifford argues that a manager’s investment horizon often shrinks to fit what their client is indicating is really important to them, where instead, manager meetings should be about how the ESG strategy is driving an investment strategy that will generate long-term, sustainable returns.
4. Select an investment consultant with the right skills
Gifford says one of the most important roles of an investment manager is to select an investment consultant who has a deep and holistic understanding of both responsible investment approaches and mainstream investment, and can be proactive in providing more sustainable investment solutions across asset classes. The author believes the majority of mainstream investment consultants lack any understanding of responsible investment, and don’t see it as their role to show any leadership in this area. While there are ESG specialists in most large investment consultancy firms, Gifford says they are primarily servicing those clients who specifically ask for them.
5. Seek positive impact on society and the environment
Gifford says progress on the PRI’s two core pillars of ESG incorporation and active ownership have been made, but these two pillars are not enough. The author says a third pillar was originally mooted but didn’t make the final cut, and should now be addressed: proactively allocating capital to make a positive impact on society and the environment. The author argues that capital needs to shift towards cleaner and more sustainable and impactful enterprises at scale, particularly those that are solving major global challenges such as climate change; water scarcity; sustainable agriculture and fisheries; deforestation and poverty. Gifford believes asset owners have a responsibility to be much more proactive in seeking out investments that deliver both market-rate, riskadjusted returns and a positive impact to this century’s big challenges.
6. Act in the best interests of clients and members
The author claims it is becoming clear that the finance sector primarily exists to serve itself, rather than to efficiently allocate capital to productive enterprises, while people are realising that their savings are being invested in ways that are not representing their interests.
Gifford believes the explosion in the use of smartphone technology and internet access in developing countries means that unethical or exploitative corporate practices have a greater chance of being exposed more than ever before. This transparency will shine a spotlight on who owns what, and hold asset owners to account more than ever for the actions of the companies in their portfolio.
Gifford contends that asset owners have been shielded from the types of campaigning that large corporations have faced for 25 years. They are often at least two steps removed from the actual negative impacts of corporate behaviour on the ground, and so it is easier to campaign directly against a company rather than a group of investors who may own less than one per cent of its shares. However, that is changing. The activities of NGOs such as ShareAction, and the continued shareholder activist work of groups such as The Wilderness Society, will only increase.
The author asserts there is also a large upside in moving in this direction. He believes asset owners will have the opportunity to be proactive and demonstrate that their investments are actually supporting ethical and sustainable enterprises, while protecting the environment. He also suggests they will be able to pick and choose among hundreds of commercially-attractive sustainable investments, and be able to proudly tell their members and beneficiaries that they are helping to build the type of world their members want to retire into. As this happens, Gifford believes asset owner institutions will recognise that they do indeed have responsibilities beyond maximising returns, and that investing in ways that also enhance and protect human and environmental values is simply the way things will be done.
RI Quarterly vol. 6: Focus on the PRI impact
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The changing role of asset owners and the future of responsible investment