Long-term Matters: Musical chairs
In recent years, environmental, social and governance (ESG) teams have tried to get closer -- both intellectually and in seating arrangements - to the company's active equity portfolio managers. And for good reason: these were the company's stars. All this led, quite naturally, to a heavy focus on ESG alpha. And useful as that journey has been, it is time for ESG teams thinking differently. Changing location will be a good catalyst.
Active equity managers have lost their mystique, and the expected return from equities has dropped. Asset owners have shifted into fixed income and alternatives, with a longer time horizon.
But the most powerful reasons for relocating are positive ones. Today, the better location is with the risk specialists. And if they are influential, the best place is with the economists/strategic asset allocation (SAA) specialists, in other words, those who are tasked with the beta.
Getting close to the risk team is a no-brainer. They are the clear winners from the global financial crisis. Their dominant models remain quantitative and conflate ‘uncertainty' with ‘risk'. But these are opportunities for ESG advocates who want to help their risk colleagues to become a bigger part of the solution. ESG analysts have to be well-informed and skilful in dialogue. And thanks to BP, Tepco and UBS, this is getting easier. Moreover, academic evidence has shown ESG analysis to be better at avoiding negative alpha than capturing positive alpha: short-term irrational exuberance is too irrational for ESG to compete with.
The best place for ESG teams to be is close to SAA. ESG professionals can best add value by working to mitigate market dysfunction, for example, addressing the way corporations manage externalities.
The caveat is that actuaries and economists are often prone to methodological and, even worse, ideological fundamentalism. But I am not alone in being pleasantly surprised by how patient, assertive dialogue makes change possible. Of course, being well-informed about economics and actuarial science helps.
ESG professionals already get the case for switching track. At a packed session I chaired at PRI's 2011 event, the audience voted three to one in favour of ESG beta (versus ESG alpha) as the best way to deliver value. This is not a surprise given the fact that 75% or more of a typical portfolio's returns now come from general market exposure (beta) rather than benchmark outperformance (alpha). So why are resources so heavily directed at chasing alpha (an inherently win-lose game) with so little spent on safeguarding beta (a proven win-win option)? This question is as relevant for ESG specifically as it is for investment generally.
Two recent papers support the case for change in the asset owner world.
Stephen Davis has teamed up with GE's former chief counsel, Bob Heineman, to produce a short paper ‘Are Institutional Investors Part of the Problem or Part of the Solution?' They highlight several issues that call into question the degree to which asset owners are helping or hindering their end-beneficiaries.
Ed Waitzer, Keith Johnson and Jim Hawley have gone a step further in their inter-disciplinary paper published by Keith Ambachtsheer's Rotman Centre. They pin the blame on decades of over-emphasis on one aspect of fiduciary duty, prudence, while neglecting others, such as loyalty and impartiality.
The result, is ‘myopic investment herding behaviours' and systematic neglect of inter-generational equity concerns.
For those who think the seating issue is a gimmick, this idea came to me from the comments of a former head of responsible investment who moved (albeit in an unplanned manner) and whose focus did shift. New actions are often the best way to change old mind-sets! So let's get moving.
Raj Thamotheram is an independent strategic adviser, co-founder of PreventableSurprises.com and President of the Network for Sustainable Financial Markets