The ESG project is well beyond its childhood, even its teenage years. PRI has been going for 13 years and SRI activity pre-dated it by a decade.
When median tenure for CEOs at large-cap companies is five years and where culture change can also take a similar time, there are reasonable grounds for saying that we should be seeing impact.
ESG is certainly the ‘new normal’. Even in the US things are moving fast. ESG professionals can expect decent career prospects and well over 50% of the institutional investment world has signed up to the UNPRI.
But looking at the real world, focusing downstream from the investment industry on the impact that corporations have, things are not healthy. Greenhouse gas emissions are once again going up. Biodiversity loss is catastrophic. Income inequality continues to rise while support for democracy continues to fall. The vital signs aren’t encouraging.
This is why investors need to shit or get off the ESG pot. This crude phrase is a way to spur action. Vulgar it may be but it’s much less obscene than the devastation to human society and ecosystems if we don’t get off the path we are on, namely to 4°C warming by the end of century.
Why focus on ESG investors? Those who have not signed up to PRI don’t pretend to be part of the solution. And while ESG investors tolerate such a big gap between walk and talk, there is little pressure on these really awful laggards.
What does ‘getting real’ mean? Here’s my 10-point plan.
● Persuade your firm to declare a climate emergency
Why? People have become desensitised to climate change and global warming and that encourages incrementalism which is the new denialism.
What’s not good enough? Not trying to change the language because you are scared about cynicism.
What challenges should you expect? Get up to speed with the recent science. List the other firms that have done this. Even if you don’t succeed first time around, it’s an opportunity to educate and build alliances.
● Focus ESG efforts on stewardship that’s fit for purpose
Why? The only metric for investors to worry about is real-world decarbonisation. This means new business models and capital reallocation.
The best way to get this is through forceful stewardship by investors – supporting net zero by latest 2050, sector transition plans and activist strategies for laggards.
What’s not good enough? ‘Business as usual’ engagement with a few companies hoping this triggers sector change. Other strategies have other purposes: sending political signals (divestment or portfolio decarbonisation); making money from the crisis (green funds); managing sector risk (divestment) or transition risk (portfolio decarbonisation). Pretending that these other strategies address systemic risk is mis-selling.
What challenges should you expect? The other strategies are easier for investors and virtue signalling is tempting. Top down support for forceful stewardship is essential.
● Acknowledge that we can’t address climate crisis without parallel movement on other Sustainable Development Goals (SDGs)
Why? Without tackling income inequality and improving social cohesion, populists and petrostate governments will use climate change to further their own ends.
What’s not good enough? To think we can tackle the SDGs sequentially.
What challenges should you expect? The 17 SDGs create intellectual overload. Aside from climate, you should focus on income inequality, gender balance and corporate capture.
● Challenge old investment theories and promote alternatives
Why? Investment professionals in the straitjacket of old investment theories like modern portfolio theory aren’t able to engage fully with real world dilemmas. They see mega trends as risks, opportunities or a mix. They don’t see that they co-create these mega trends. Similarly with the Taskforce for Climate Related Disclosures (TCFD) the focus is on how climate change affects portfolios.
What’s not good enough? Bolting on sustainable finance actions to old investment theories will not work.
What challenges should you expect? As Keith Ambachtsheer has said in more polite language, CFA training tends to be backward looking and to duck hard challenges. Bolting on (voluntary) ESG modules but not changing the core curriculum is evidence. Challenge the worst aspects of MPT-related behaviour, like portfolio return. Disseminate new evidence that challenges old theory.
● Encourage employees to find purpose
Why do this? All investment employees (not just front office staff) need to find their own solutions. Empower these professionals to link ESG with their own personal purpose.
What’s not good enough? A command and control approach to genuine ESG integration and stewardship won’t work. Training is useful but not a substitute for culture change.
What challenges should you expect? Investment professionals don’t know how to bring their values to work so expect some ‘conscious incompetence’ and staff turnover
● Adopt gender balance and cognitive diversity
Why? Decision-making groups with genuine gender and intellectual diversity are more likely to address systemic risks. There is good evidence that gender balance and true diversity is not an obstacle to financial performance and can often boost it.
What’s not good enough? Investment firms unwilling to act are unlikely to want to engage in meaningful stewardship activity with investee companies. And a token woman is yet more of the problem.
What challenges should you expect? Immunity to change from middle aged and older white males shouldn’t be accepted.
● Re-engineer the supply chain/structural re-design
Why? Genuine integration of ESG is unlikely without structural change in investment supply chains. This could mean an asset owner bringing more investment activity in-house or re-negotiating relationships with traditional research.
What’s not good enough? Bolting ESG research services on to existing structures/supply chains is unlikely to work.
What challenges should you expect? Sustainability focused supply chain management is notoriously hard: investors can learn from corporations with more experience.
● Educate current clients and look for better aligned new ones
Why? Without informed, supportive client demand, investors are unlikely to do what they really can vis-à-vis externalities in general and systemic risks in particular.
What’s not good enough? Pretending you can have any client you want (Gulf state SWFs, pension funds of major fossil fuel companies) and that these conflicts of interests will have no impact on stewardship.
What challenges should you expect? Traditional sales staff never turn away assets and so counter-cultural training and incentives are needed.
● Define when enough AUM is enough
Why? If the thing that matters most is continuous organisational growth, it is highly unlikely that genuine ESG integration and forceful stewardship will get the focus they deserve.
What’s not good enough? Pretending that never-ending growth is ok.
What challenges should you expect? ‘Growthism’ bias is endemic especially in commercial organisations. The c-suite should define optimal or maximal AUM, portfolio stock and stewardship team sizes.
● Shift remuneration of employees to focus on the long term
Why? If investment professionals are rewarded for short-term performance against peer groups or a benchmark it is unlikely they will see it as part of the day job to consider systemic risks.
What’s not good enough? Treating the long-term as simply a series of short-term steps is delusional when dealing with externalities in general and fat-tail systemic risks in particular.
What challenges should you expect? Some staff will leave. To generalise, it will be those who do not accept the changes described here – this is good staff turnover.
Raj Thamotheram is a founder and chair of Preventable Surprises
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