ESG : SOCIAL INVESTING = INVESTING by Caleb Gibbons

Even the Asian elephant in the room is endangered.

Over 80% of the market value in the S&P is attributable to intangible factors (environmental capital, sustainability governance and stakeholder relationships). Less than 20% is accounted for by physical and financial assets.

Global sustainable investing assets grew by 61% over the 2012-2104 period and now stand at $21.4 trillion. The domicile of these assets is telling; 99% are in the United States, Canada and Europe.

Environmental and social issues affect both valuation and financial performance. If your investment decisions focus only on financial disclosures, you will not be getting a complete picture of the drivers of value.

Global ethical principles have never been more important or, it appears, more wanting than in current times (i.e. VW, Phoney Express aka Well Fargo, global Trumpism, and global lawsuits imperiling not just returns but the very viability of global commerce beyond national borders).

 

ESG ProgramsThe UN supported Principles for Responsible Investment (PRI) ,a not-for-profit organization, held their 10th anniversary conference in Singapore last week (Sept. 6-8th) which I attended. No conference bag full of binders and junk mail at this conference, your 1 page agenda fold up into your name tag and all meals were vegetarian, a subtle but effective message. Forbes Magazine The conference domicile was not chosen by chance. Asia has been termed the cradle of disorder for a reason, it is home to 5 of the world’s 7 billion population and on metrics of social investing if the game has even started it is is the 1st inning. When a region has practices like dynamite fishing and farmers still clear land with a match much work lies ahead.

Chris Sanderson, Co-Founder of The Future Laboratory focussed largely on the sustainability of the capital markets. He characterized global citizens as being tired of austerity, wary of politicians and perhaps even more wary of brands. Backlash culture; http://shop.thefuturelaboratory.com/products/backlash-brands-report.

Elliott Harris, Head of the United Nations Environmental Program (UNEP) gave a rousing speech on environmental and social sustainability. The end game is that all investments will be social. Elliott introduced the concept of thick profit versus thin profit, a concept akin to quality, hard to define, but you know it when you see it.

Georg Kell of Arabesque Partners Arabesque spoke of  Generation S, a cross-section of all age groups working towards making the world a better place, one worthy of handing down to future generations. While ESG (environmental, social & governance) alpha may prove illusory, ESG smart beta appears to have legs.

Millennials were of course discussed with the most shocking realization being that the oldest ones (born 1990) are in their mid 30’s now! Generation D (Digital), whose only need or want in life is wifi and lithium, was out in full force, albeit well behaved and overall attentive. The 600 conference attendees were largely baby boomers, representing approx. 50% of global financial assets under management (AUM), signatories to the PRI whose mission states, “We believe that an economically efficient, sustainable global financial system is a necessity for long term value creation. Such a system will reward long-term, responsible investment and benefit the environment and society as a whole.” Clear, concise, devoid of the typically mumbo jumbo one gets when issues like climate change and the environment are normally tabled.

The session run by GS alum David Blood, Managing Partner at Generation Asset Management Generation Investment Management was excellent. Al Gore is the Chairman of Generation Investment Management. If Obama delays the election to allow Clinton to get her legs perhaps they could run as a Third Party choice? Could not lose with the ticket “Blood & Gore”. Both men can readily point out Aleppo on a map too. In any event, David’s sage words rang true to all in attendance. Finance and capitalism is not working for everybody was a key statement. The transition to a low carbon economy will clearly not be an easy one. A full 1/3 of aggregate world equity and fixed income market value lies in the cross hairs. We can do this the hard way or the easy way, but de-carbonization is a trend now moving under its own power. Mr. Blood noted that while the majority of global asset managers in attendance (120 signatories, 50% of global AUM) were managing to sustainability factors, those not present (i.e. non PRI Signatories) are largely American. The reasoning to date for USA firms reluctance is that becoming signatory could put them in breach of their fiduciary duty. We must collectively get the remaining 50% on board as priority #1.

Investing for the long term. Short termism. A great panel on investing for the long term had some serious panel power. The headliner was Hiro Mizuno, CIO of Government Pension Investment Fund, Japan (GPIF), the world’s largest funded pension plan. GPIF manage their liabilities to a 100 year time frame. Their most recent result showed a loss of ¥5.3tln (US$5.2bln) for the current fiscal year through March 2016. The fund’s quarterly loss through June 30, 2016 was > ¥5tln (-3.88%). They run ¥130 trillion (US$1.27 trillion) leading Mizuno-san to characterize the latest qtly loss as peanuts. The joke was not well received, perhaps because it was so unexpected, leading Hiro to quip that perhaps there were Japanese pensioners in the audience. The fund increased their allocation to equities in recent years. Global equity investment totals US$600bln, 80% of which is allocated in a passive fashion and 20% ($120bln) of which is actively managed. All investment are mandated to external manager, counter to the global trend in the pension arena of in-sourcing. Fellow panelist Paul Smith, President & CEO at the CFA Institute noted that one advantage of being old is that “you see everything twice” with such decisions as out-sourcing vs. in-sourcing set to very long term market cycles.

Several panels touch on infrastructure finance with GPIF mentioning their joint investment effort with Canada’s CPP on ESG brownfield infra projects. Mizuno-san noted the challenges of crafting/originating greenfield projects as funding challenges often drive the cheap option and the cheap option is usually dirty (materials, supply chain, etc.). GPIF will not finance dirty deals, full stop.

A deeper discussion ensued on better was to measure and compensate performance with a general aversion shown to managing to qtly earnings guidance. The average hold period for SPY, the > $100bln S&P 500 SPDR, the largest ETF tracking the benchmark for US stocks is 5 days. In the last 15 years 52% of the Fortune 500 companies as no longer in existence. In 1955 the average Fortune 500 company life expectancy was 55 years, in 2015 it is 15 years. Traditional valuation metrics clearly must evolve to address the realities.

ESG toolkit for Fund Managers: http://toolkit.cdcgroup.com/

The ESG investment construct must be turned on its head, to my mind. Social investing = investing and “dirty” or non-socially minded investment should be the type requiring explicit sponsor/board/member approval. JCG

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Shenzhen “beach” September 2016