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Thinking Sustainably With The Investment Integration Project

A conversation about how investors are exploring how to effect sustainable change

Jon Hale, Morningstar Research Services LLC

 

Investors across the spectrum—individuals, asset managers, pension funds—are increasingly seeking information on the environmental, social, and governance, or ESG, factors affecting the holdings in their portfolios, such as that conveyed by the Morningstar Sustainability Rating™ for funds. But that’s the tip of the iceberg: Investors are extending their interest in ESG at the company level to system-level impact investing that aims to effect sustainable social change.  

System-level investing is informed by the United Nations’ Sustainable Development Goals, or SDG—17 broad global goals established in 2015 that cover individual well-being (such as ending hunger and improving health) and societal and environmental aims (including climate action and reducing inequalities).  

Morningstar hosted a conference this past February with The Investment Integration Project, or TIIP. The conference explored TIIP’s research on system-level and SDG investing. Panels of industry leaders delved into the challenges and opportunities ahead. The experts included Steven Lydenberg, founder and CEO of TIIP and partner at Domini Impact Investments; Robert Eccles, founding chairman of the Sustainability Accounting Standards Board and visiting professor of management practice at Saïd Business School, University of Oxford; and Anna Snider, head of due diligence, global wealth and investment management CIO office at Bank of America.  

After the event, Lydenberg, Eccles, and Snider shared their insights with me. Our Feb. 8, 2018, conversation has been edited for length and clarity.  

Hale: Steve, you’ve said your project acronym, TIIP, is a play on words to suggest a tipping point. It seems to me that we are nearing a tipping point for sustainability, perhaps ushering in a new era of sustainable capitalism, which I would characterize as an attempt to make the global economy more resilient and work for more people over the long run. What’s your take?  

Lydenberg: When we set up The Investment Integration Project three years ago, we deliberately chose the acronym TIIP because we saw a tremendous uptake of the idea of ESG integration and various impact investing products in the investment community. It wasn’t clear to us whether this signaled a tipping point, a change in the fundamentals of how investment is conceived in terms of its role in society, or whether this was a niche market that was being created. But over the past three years, we’ve seen a number of indications of fundamental change. There’s been an increase in the number and the size of the investors, asset owners, and asset managers who are implementing a variety of strategies and tactics that indicate to me that investors are playing a larger, more systematic role in benefiting society.  

Hale: Bob, I assume you would agree that investors are starting to look at what they do with a different lens. Why is that? Can they expect better performance out of their investments if they do?  

Eccles: I do think investors are looking at things through a different lens. They’ve been late to the table compared to the corporate community. The corporate community was talking about sustainability for some 20 years. There was a fair amount of greenwashing, and there still is, but I think there’s less of it. The Sustainable Development Goals certainly have contributed to that. And the investment community is now pretty serious about sustainability. There used to be a prevailing belief that if you integrate ESG issues, you’re going to hurt returns. We’ve found that most people don’t believe that anymore.  

Part of the issue is getting clarity about what we mean by ESG. The work of the Sustainability Accounting Standards Board, which was a brainchild of Steve and Jean Rogers, was to show that there is a subset of issues that are “material” for a company. If we could shift the language from sustainability to materiality, that’s a language that more CFOs will understand. There are some sustainability issues that either will hurt your financial performance if you manage them poorly, or will help if you manage them well. There’s a growing body of empirical evidence that shows a positive relationship between ESG performance—at least at the stock and the portfolio level—and financial performance.  

Then there’s the system level, where Steve is working. Anne Simpson, investment director, sustainability, at CalPERS will tell you that they have a 100-year tail liability when they consider system-level issues and the impact on the beneficiaries whose needs they have to meet. She uses the example of the financial crisis. Climate change would be another one. Inequality would be one. If we don’t address these system-levels issues, they won’t be able to earn the 7.5% per year that is needed to meet the needs of the beneficiaries. That’s not going to happen if the whole system is screwed up, because we can’t diversify away from it. The returns of pension funds with very long-term views and these gigantic asset managers are going to be subject to how things are going on the planet—the only one we have.  

Hale: You mentioned that corporations have been ahead of investors on sustainability issues. Was Larry Fink’s letter to CEOs a signal that BlackRock is now thinking more at the system level?  

Snider: Fink has been writing for a long time about long-termism. He, along with a number of CEOs who are part of CECP  and similar organizations, have been talking about financial systemic risk based on this predominance of short-termism. Everyone, from the individual investor to the CEO, makes decisions based on short-term thinking, on a quarterly basis, and that is affecting the stability and the health of the financial markets.  

Fink has been writing letters to CEOs very openly for a number of years now, but I think this letter marked a change in how corporations see themselves, and I think in how BlackRock also sees itself. BlackRock, through its iShares business, is one of the largest passive investors in the world. When you are forced to hold a set of securities in a benchmark, you’re not pulling securities out or putting securities in based on ESG characteristics like a fundamental investor might, and like many do. You have to enact change in a different way so that the index continues to move forward from an ESG perspective. The strategy there is to benefit the underlying clients in these passive structures while trying to enact change in a different way than you would from a fundamental investment standpoint.  

This blog post is adapted from an article that originally appeared in the April/May 2018 issue of  Morningstar magazine. Read the full article or subscribe for free.

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