ESG: Towards a more purposeful capitalism
Fiona Frick - Group Chief Executive Unigestion
- Asset managers have a duty to not only deliver returns for clients, but also to provide capital to support the sustainable development of our economy.
- Portfolios will increasingly be measured not only on two dimensions i.e. risk and return but on three dimensions: risk, return and ESG.
- Europe has taken the lead in evolving its position on ESG but the US will catch up.
Over the past decade, ESG investing has moved from a niche business to the most important trend in the asset management industry. This shift has occurred for many reasons, but key among them is the deteriorating climate situation that, while only one part of ESG investing, has rightly moved to the forefront in recent years.At a point where the likelihood of achieving the 2015 Paris Agreement target (limiting global warming to well below 2° compared to pre-industrial levels) looks extremely challenging, the global asset management industry is presented with a tremendous opportunity to reshape its role and reputation. With the current pace of change, the largest companies in the world (measured by the MSCI World Index) are collectively on course to deliver global warming of above 4°, well above the Paris Agreement’s objective.
It doesn’t have to be this way. Asset managers are the guardians of approximately $110trn* of assets, and represent a crucial link between investors and the financing needs of the real economy with the power to allocate capital to sustainable businesses and influence them through voting and active engagement. If we grasp this opportunity, we collectively have the power to force change for the benefit of society and future generations.
Over almost two decades I have been on a responsible investment journey at Unigestion, initially as a portfolio manager and during the last decade as CEO. Today 84% of our investments, from equities to private equity, are currently covered by ESG considerations. We recognise we have much more to do as we move on our own journey from ESG integration to having more impact on sustainability over the coming three years, but I am proud of what we have already achieved.
The global asset management industry is presented with a tremendous opportunity to reshape its role and reputation.
I have learned many things during this time and evolved my thinking of what needs to be done, both at Unigestion and across our industry, if we are collectively to fulfil our potential as a positive force for the future with a renewed, responsible and respected role in society. Over the coming months, I will be sharing these thoughts in a series of articles that combine to present a transparent assessment of what I have personally learned, where we are as an industry and at Unigestion, and what needs to happen from here.
Part one: towards a more purposeful capitalism and fiduciary duty
Does the shareholder value maximisation philosophy, as espoused by Nobel economics laureate Milton Friedman in 1970, still work in today’s climate-challenged world?
Today, I would argue that Friedman’s analysis, which argued against the inclusion of social factors into company valuations and had a significant influence on economic policies around the world, has proved to be harmful not only for wider society, but also for shareholders themselves.
Classical economic theory is ill-equipped to describe the interdependence of finance, business, the economy and society in broader terms. Neither does it account for multi-generational economic transfers, in which current generations are willing to forgo consumption with no recompense in order that future generations can benefit.
This has never been more true than today, given the impact of the Covid-19 pandemic on all aspects of our lives. The global economy is gradually emerging from the crisis in desperate need of growth. Nevertheless, the end goal should not be growth at any cost but rather, sustainable economic expansion that minimises the risk of another major crisis.
In the inspiring “Reimagining Capitalism in a World on Fire”, published in 2020, Harvard professor Rebecca Henderson discussed the need to rewire capitalism. Despite it being the most successful economic system in history, it is now in danger of destroying itself. Fewer and fewer young people believe it is a system that works. She gets to the heart of what’s wrong with modern capitalism and lays out a pragmatic roadmap for how businesses can help drive the systemic change needed to build a capitalist society that works for everyone.
According to the book, we are moving towards a better and fairer world, where companies can do ‘good’ while making profit. By focusing on the relationships between purpose, innovation and productivity, the corporate sector and the finance industry can play a major role in building a more sustainable economy.
Asset managers are a crucial component of the solution. Unlike banks, which use short-term funding to allocate capital, asset managers use the long-term funding entrusted to them by investors and so represent a crucial link between them and the financing needs of the real economy. Asset managers therefore have a duty to not only deliver returns for clients, but also to provide capital to support the sustainable development of our economy.
This shift to stakeholder capitalism has been gathering pace since the Global Financial Crisis and has been further accelerated by the Covid-19 pandemic. Indeed, in April 2020, the World Economic Forum, together with members of the business community endorsed six stakeholder principles for the Covid-19 era including a commitment to continue to embody ‘stakeholder capitalism’ and ‘continue our sustainability efforts’.
Fiduciary duty reimagined
In such a world, the fiduciary duty of asset managers needs to evolve to take account of environmental and social emergencies such as climate change and their impact on the companies we invest in.
Historically, the fiduciary duty of an asset manager was to deliver a risk adjusted return that was suitable for the client. I think that in our current world, fiduciary duty will evolve into something that addresses not only the financial outcome we deliver to our clients, but also, what we deliver to society.
Fiduciary duty should be about delivering long-term sustainable returns. This means investing responsibly in companies, industries and sectors where there is an objective to create a sustainable future for society.
We have undertaken a great deal of research on the interaction between ESG criteria and its impact on investment outcomes. Our analysis has shown that adding both bottom-up and top-down ESG restrictions into the portfolio construction process does not change the efficiency of the portfolio in an economically significant way. On the contrary, there is evidence of a marginal improvement to the risk-adjusted performance and downside protection when ESG risk considerations are applied. This means investors can achieve their objectives in terms of both risk and performance, while at the same time addressing their ESG preferences.
I believe that portfolios will increasingly be measured not only on two dimensions i.e. risk and return but on three dimensions: risk, return and ESG. Consequently, the two-dimensional risk and return model, as per Harry Markowitz’s Modern Portfolio Theory, is no longer sufficient to construct portfolios. Instead, in order to meet this sustainability objective, we need to move towards a three-dimensional model that considers not only the risk and potential return of an investment on asset allocation, but also its impact in terms of E, S and G.
The evolution of our fiduciary duty as asset managers will permit us to better explain to those outside our industry what asset managers do: facilitate economic growth. But not any kind of growth; sustainable growth. Our current economy needs huge amounts of capital to stimulate growth and our task as asset managers is to channel this capital from savings into the economy. We are in a position to allocate capital to the right sector and the right company and then continuing to engage with those companies to ensure they remain on an appropriate trajectory towards sustainability. By doing so the asset management industry can contribute to rebooting the global economy in a sustainable way while ensuring robust returns for investors.
The role for institutional asset managers such as Unigestion is to help create a world that people want to retire into – providing attractive returns sustainably. We have a positive role to play, and this is welcome news for an industry still suffering from an image problem after the Global Financial Crisis. The Edelman Trust Barometer, which scores sectors on their perceived trust among consumers, highlights how poorly the financial services sector is regarded over a decade after this crisis.
Playing an active role in the delivery of sustainable growth gives us an opportunity to recalibrate perceptions of financial services, and restore some of that lost trust.
Dual speed: Europe versus the US
According to a study undertaken by Aviva in 2020, some 40% of pension funds in both Asia and Europe have already committed to reaching net zero carbon emissions by 2050 but just 17% of North American pension funds aim to do so.
This is quite an eye catching difference and reflects the different political and regulatory environments that exist in these different parts of the world.
While responsible investing has its roots in the 18th Century Methodist movement in the US, in more recent times, Europe has taken the lead in evolving its position. This difference in commitment can be attributed in part to the pace of regulatory reform and shift in the role of fiduciary duty over recent years on each side of the Atlantic.
In Europe, financial regulators are increasingly scrutinising the impact that the decisions and investments made by asset managers’ investments have on society as a whole, in turn forcing fiduciary duty to evolve, shifting responsibility for these decisions from the underlying client onto the investment manager. The introduction of the EU Action Plan on Sustainable Finance (SFDR) in March 2021, for example, is a key piece of legislation that aims to reduce greenwashing by demanding increased transparency and, as a by-product, will help redirect capital flows towards a more sustainable economy. This will intensify the trend towards a new definition of fiduciary duty.
The US is currently in a very different position. Under Trump’s presidency, the US withdrew from the Paris Agreement in June 2017 and repealed the Clean Power Plan in 2019. Then, in 2020, the Department of Labor (DOL) effectively put ESG investing on ice by ruling that fiduciaries have an obligation only to act in the best interests of beneficiaries, meaning that asset managers would need to prove that any ESG considerations would not damage their performance objective.
However, there has already been swift change under President Joe Biden, who signed a letter on his first day in office to re-join the Paris Agreement and ordered the DOL to review its rules. Encouragingly, the US Securities and Exchange Commission (SEC) has also moved ahead with a plan to put ESG disclosures under the microscope.
The situation in the US is clearly evolving rapidly and it will undoubtedly catch up in terms of regulation and the fiduciary responsibilities of asset managers, but for the time being, Europe and European asset managers might be able to lead the pack in this very strong evolution of our industry.
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