Guest Viewpoint: Christopher Ailman & Mark Walker
Words matter, but sometimes they can get in the way. Impact investing, mission-based investing, responsible investment, double and triple-bottom-line investing, ESG factors, and even sustainable investment. All of these terms can have both positive and negative connotations for investors.
Some embrace these concepts and feel it is mandatory, or critical, to their fiduciary duty. Others reject these terms, and feel they distract an investor from seeking the maximum return, which therefore violates their fiduciary duty. One CIO said that ESG is just a code for losing money. To him, it was social investing first and investment returns second.
Sadly, these words have become polarising. We feel they have worsened the dialogue and debate among long-term investors. The words cause division. If an investment officer’s title includes ‘responsible investment’, what does that imply about the rest of the staff? Are they irresponsible investors? If an investment is labelled as impact or double-bottom-line, does that imply the maximum return has been reduced or diminished?
Let’s forget about those words and talk about long-term investing. Most investors, especially sovereign wealth funds, pension plans, and endowments all agree with, and believe in, long-term investing. Most have an investment horizon over 30 years, some even have a multi-generational horizon. It is their fiduciary duty to think and act long-term. Quite frankly, short-term trading profits don’t help these portfolios unless those short-term trades can be repeated over, and over, and over again, for years on end.
What about business risks? This is another term that investors consider important. Risk, and specifically business risk, is a critical component of proper due diligence and corporate management. Put these terms together: long-term business operational risk – that’s MBA school 202. Understanding the drivers and threats of long-term business risk is ‘SWOT’ after all – internal ‘strengths versus weaknesses’, and external ‘opportunities versus threats’. These are accepted terms that management and investors can all agree upon. Using these terms puts everyone on the same page with a shared understanding.
The problem is that ‘long-term operational business risk’ is not as snappy as ‘responsible investment.’ But, we would argue they are the same thing to a long-term institutional investor. Think for a moment about the types of risks that can cause a business to lose market share, or worse, lose its social licence to operate. Immediately one considers product safety, production and accidents, obsolescence, supply chain problems, labour unrest, criminal activity, Government fines or sanctions, the list goes on. These are the types of risks a good management team and long-term institutional investors work to minimise or eliminate.
Fixed-income credit investors hound management and interogate the corporate disclosures to ensure these long-term operational risks are being managed. Deep-value equity investors read through the disclosure documents and interview management to understand the level of these risks and how they are being mitigated. Even private equity buyers pour over due diligence documents and corporate disclosures. Once they buy, they work diligently to minimise and manage these risks. Long-term business risks are a real threat to both equity and debt investors.
If a business can properly manage these long-term operational risks there is a high likelihood it will be in business for a long time. If it is profitable, then it is a good long-term investment, producing a sustained return over decades. Put another way, it is a long-term sustainable return, something all fiduciaries desire.
We propose that the industry needs to focus less on acronyms and instead think about long-term operational business risk. Management and investors need to focus on matters that are material to the company and can impact it over the long-term. That is solid investing, no matter what label you give it. We need to get investors and corporate management thinking long-term. Make decisions that will pay rewards over the next decade and even longer. Far too many investors and corporate managements think short-term; they primarily focus on the next 91 days, quarter to quarter. That is a blink of an eye to a long-term investor or a sustainable company. Let’s focus more on the long-term horizon, not just the next step.
Next time you hear about ESG investing, think of long-term operational business risk. If someone says ‘mission-based investing’, the answer should be yes, we focus on our mission to generate risk-adjusted returns over a very long-term time horizon. If someone asks if you are a responsible investor, the answer is of course, because we’re long-term investors. The question itself implies one would choose to be an irresponsible investor, which would violate most global fiduciary standards. Do we focus on long-term business risk when making our investment? Yes, of course. Does that imply we are responsible? As a fiduciary you must be responsible. Risks matter. Enough said.
Christopher Ailman is chief investment officer of CalSTRS and Mark Walker is chief investment officer at Coal Pension Trustees