From the catastrophic Australian fires at the beginning of 2020, to the extraordinary events in Washington this month, and the many pandemic missteps in between, the issues that occupy responsible investors grow ever more pressing. But as Kermit the Frog sang, it is not that easy being green. And when he called rainbows ‘only illusions’, he may have foreseen the illusory, but insubstantial connection between many responsible investment products and the Sustainable Development Goals.
Individual consumers can engage in the wishful thinking underpinning these and perfunctory responsible investment can suffice for commercial purposes, fiduciaries lack these luxuries. Differentiating responsible investment quality among products, services and provider capabilities is mission-critical for investors dependent on the ‘real world’ outcomes that underpin future investment opportunities.
For the institutional-grade analysis required in a field where activities can range from shareholder engagement to short selling; and reasons from religious observance to risk management, a robust model of responsible investment is needed. Regnan introduced such a model in its working paper, On Purpose. It proposes that principled (versus opportunistic) responsible investment is characterised by intervention in conventional investment practice to pull it into alignment with ‘real value’.
‘Real value’ contrasts with conventional investment’s preoccupation with ‘the price of everything and the value of nothing’. Examples include portfolios insensible to catastrophic losses of species, habitat, and natural resources on which life depends; or markets that erode the institutional integrity or community cohesion on which economic development and commercial enterprise depend.
Reasonable people differ about details of what constitutes real value. However in our experience this is often a distraction from the more fundamental questions. One clients’ internal stalemate followed impassioned debate about what fossil fuel activities to ‘screen out’ from an equities allocation, given the beneficial activities (such as healthcare) that use them. Yet participants were unable to articulate what they intended such screening to actually do.
Regnan proposes that responsible investors formulate strategies, choose service providers, and evaluate their responsible initiatives systematically, based on how ambitiously, how effectively, and how consistently each drives alignment of investment with ‘real value’ (however defined). For example, climate-focussed offerings can be differentiated by the climate outcomes they seek (corporate disclosures vs national decarbonisation?); the credibility of their chosen methods (adjustments to proprietary stock valuations? Or publishing novel research?); and their consistency (a single product? Or consistent for all corporate activity?).
The power of the ‘intervention’ model of responsible investment lies in its illumination of its activities in context. For example, requesting a screened investment option might be the most ambitious intervention available to a single individual in a million-member pension scheme. It is a less ambitious intervention for the institution able to influence suppliers, industry peers, and issuers. Similarly, publishing ESG analysis that disrupts market norms is a more effective intervention than applying the same analysis solely for alpha within a proprietary portfolio.
The SDG rainbow might well be the first that leads to a pot of gold, as sustainable economic development creates future investment opportunities. But investors must be willing to differentiate real RI from distractions merely dressed (like leprechauns) in green. Being green, in contrast, “might not stand out like flashy sparkles in the water” as Kermit lamented. Then again, he found much richer opportunities once clear of the swamp.
For more on a functional framework for responsible investment see On Purpose: Towards a Unified Theory of Responsible Investment.
Susheela Peres da Costa is head of advisory at Regnan, the responsible investment boutique owned by Pendal Group Limited.