Integrating impact alongside risk and return is a revolution that will see more diversification among investor allocations to asset classes such as commodities. Elsewhere, it requires using multiple data sets to analyse stocks and sovereign bond allocations to see the real-world impact of a company’s product or services, and which governments are heading to net-zero. Bridgewater’s head of investment research Karen Karniol-Tambour explains.

A key first step in integrating impact in public markets is for investors to assess what real world outcomes they actually want to impact. It involves a shift to think about investment not just in terms of risk and return, but also in terms of impact.

Karen Kaniol-Tambour, head of investment at Bridgewater, the world’s largest hedge fund, explains that integrating different types of risk is now normal and deeply engrained. However, shifting to also think about impact as deeply and rigorously as risk and return is nothing short of “a revolution.”

Assessing the real-world outcomes investors want to impact involves looking at the services a company provides and how it behaves making those goods. As for investing in fixed income, investors should look at the actions the sovereign government is taking to shift outcomes in the real world like climate change.

In commodities, investing for impact means choosing to invest in commodities that will build carbon free economies like charging infrastructure and electric vehicles, or investing in clean and sustainable mining processes.

“This is the framework, and these are the relevant questions to ask,” said Karniol-Tambour who oversees an investment team of 150 proffessionals. From this process she said it is possible to see what assets have the most impact, and which have the least, and give impact as much credence as risk and return within a portfolio.

Expanding on the process within equities, she outlined how looking through an impact lens could lead to investment in a utility for its real-world impact on clean water and sanitation.

“This is an example of how you might measure a company,” she said. In the bond market impact investors could tilt to a government developing a low carbon economy for example.

Investors can apply risk, return and impact to the issues they care most about from climate change to biodiversity or labour rights, across their entire portfolio. With climate change, investors can look at stocks and analyse companies’ emissions and the products they make. They can also look at externalities and analyse “if a company was charged real money against the damage done, would their profit drop.”

Karniol-Tambour said that measuring impact is still in its infancy – “like risk many years ago” – but she said progress is accelerating fast because more investors are making it a priority. In a few years we will see a whole other level of being able to measure impact, she predicted.

“It is very undeveloped and has tremendous potential,” she said, citing developments like the work of Harvard Business Schools’ Impact-Weighted Accounts Leadership Council of which she is a member. Moreover, demand for impact is also being driven by the huge government stimulus to counter the effect of the pandemic, much of which is going into the transition.

Data is crucial

Bridgewater uses data from between five to 10 providers, picked from an initial pool of around 40 based on their ability to answer key questions around measuring impact. She also stresses the importance of triangulation or using more than one method to collect data on the same topic. This helps prevent the risk of personal opinions seeping into the measuring process.

“None of us are true experts on these topics,” she says.

As for interesting patterns emerging from the data, she said investing for impact in equity doesn’t require a new level of diversification. An experiment that took fewer than normal (around 50) of the best performing stocks from an impact perspective, found diversity levels didn’t fall away. Conversely, investing in commodities for impact does result in greater diversification given investors typically hold oil more than any other commodity. Investors wanting to impact the green transition need to expand away from oil to invest in commodities like copper or aluminium, she said.

“From an impact lens there are lots of commodities that need to be ramped up while carbon is phased out,” she said, adding that the most important source of diversification is towards environments investors are not exposed to.

“Put another way, investors should think what impact options they should add. Think what kind of environments you are not well diversified towards,” she said.

Index construction

Karniol-Tambour explained to delegates that many equity indices try to achieve ESG goals by “demanding” the sector mix stays the same as the underlying market mix. It means the index often ends up being the same as the market.

“In our view this is limiting your impact,” she said.

Bridgewater has built equity indexes shaped around the SDGs without these constraints. Instead “back-end checks” monitor the extent to which the index incorporates a sector tilt, for example. The process has revealed that passive investment, which changes all the time due to shifts in a company’s market cap or a sector market cap, has a bigger effect on how bias plays out in a portfolio than impact.

Finally, she counselled on the importance of finding ways to apply measurements systematically.

“If we can only make a qualitative assessment on one company we are limited and assessments need to be scaled up,” she said.

She also reiterated the danger of bias in qualitative assessments, stressing the importance of “as much opinion as possible.”

Achieving diversity requires data, new recruitment practices and nurturing inclusion. And the financial industry must get its own house in order to better put pressure on investee companies.

“Inclusivity is more important than diversity. Don’t underestimate how hard it is to understand what an inclusive culture looks like,” David Neal, chief executive at IFM Investors, told delegates at the “Sustainability Digital: A Planet in Trouble” last week.

Neal, who has led the  the investor-owned fund manager was citing a key challenge inherent in solving the diversity problem within financial services organisations.

He was speaking alongside Helena Morrissey, chair of the Diversity Project and founder of the 30% Club which seeks at least 30% representation of women on all boards and C-suites globally, and Jason Lamin, founder and chief executive of fintech Lenox Park Solutions. They agreed that hiring diverse employees must be accompanied by inclusivity so that people feel able to voice their opinions and be part of the corporate culture.

Delegates heard how granular data helps reveal where firms are losing diversity in their workforce, enabling companies to “zero in” on challenges like retention. Elsewhere, asset owners need to hone clear and consistent messages and view tackling diversity in the context of change management overseen by strong line managers.

Data: the challenge and the solution

More asset owners are drawing on high end data to increase gender diversity, said Lamin visible in the growing number of investors using Lenox Park’s scoring and methodology data over the last year. Using metrics that assesses and measures factors like board diversity amongst investee companies and asset managers, asset owners can tilt allocations to those that score highest and “move the needle.”

He says that assessing, managing and changing diversity, equity and inclusion is set to become the data issue of the 2020s, as investors turn their attention to the power they have to advocate for change in the companies they invest in, and the firms that manage their money.

People have discussed the importance of diversity for decades and everyone understands the social good inherent in diversity. Yet the catalyst for change has only come since investors started looking at diversity through a risk lens.

“This has provided a different motivational factor,” said Lamin, citing diversity risks like group think, the inability to attract the best talent, or the reputational risk that comes with discrimination or staff harassment.

IFM’s Neal reiterated the risk of group think and the importance of “different life experiences” to help solve “complex problems.”

Moreover, the COVID-19 pandemic and growing evidence that the impact of the pandemic is more keenly felt amongst women, requires a “big” push.

“If we are going to contribute capital and build back better, we have to pay attention to diversity and inclusion,” he said.

IFM is working with researchers at the University of Sydney for insight on investing through a gender lens. Neal told delegates that changing the fund manager’s investment process requires “asking the right questions.”

When David Neal was chief executive of the Future Fund, a position he held before joining IFM last year, his team engaged in a mapping of the cognitive diversity of the group.

Now he has expressed his hope that investor appetite to address diversity will gather the same kind of momentum now seen in climate where he noted a similarly “slow response to clear evidence.”

“I am hoping momentum will also build around investing with a gender lens,” he said.

Neal added that asset owners’ ability to push firms on gender equality depends on the ownership level of the investee company.

“One hundred per cent ownership gives a different level of control,” he said. “It makes it easier to build an inclusive culture and set up the right employment policies to encourage women and minorities and make sure the board and executive level are diverse.”

“We try and get into the organizations we invest in as deep as possible – in the same we way we manage issues ourselves, in our own organization.”

Getting our own house in order

Panellists stressed the importance of asset owners and the wider investment community ensuring diversity within their own ranks before they take the message to investee companies.

“We have to get our own house in order,” said Morrissey.

“We can’t go around lecturing people when the financial industry is not diverse.”

She urged investors to change recruitment processes and rely on data. For example, data reveals when and why diverse candidates leave a company or if diverse candidates are being promoted. She also highlighted the importance of grass roots initiatives around diverse recruitment and encouraging people who might not have considered a career in finance into the industry.

“We need their representation,” she said. As well as building diversity in early careers, she said more needs to be done around return-ship and encouraging women back into work.

No more all white boards

Panellists also sounded a note of optimism and pointed to recent progress. Like the fact there are no all-male boards left across the FTSE 350 in a victory for the 30% Club.

“We are thrilled with the progress around more women on boards,” said Morrissey who observed how men are helping push gender diversity in new trends in allyship. This has pushed the conversation beyond gender equality and the boardroom she said, noting “there are so many underrepresented groups.”

Progress in other areas like racial diversity will also require a “painful journey” that “takes a while” and involves “steps back,” she said.

Morrissey also reflected on how the 30% club would have failed if it had begun with a broad scope. The organization’s success is rooted in its narrow focus on female boardroom representation, she said.

 

In a fireside chat, Gloria Steinem – often called the world’s most famous feminist who has been advocating for women’s rights for 55 years – reminds us why diversity is such an important issue for investors to understand, why it impacts society, business and investments so fundamentally, and why there is still so much work to do.

Speakers

Gloria Steinem is a writer, lecturer, political activist, and feminist organiser. She is particularly interested in the shared origins of sex and race caste systems, gender roles and child abuse as roots of violence, non-violent conflict resolution, the cultures of indigenous peoples, and organising across boundaries for peace and justice. She now lives in New York City, and is the author of the travelogue My Life On The Road.
In 1972, she co-founded Ms. magazine, and remained one of its editors for 15 years. She continues to serve as a consulting editor for Ms., and was instrumental in the magazine’s move to join and be published by the Feminist Majority Foundation. In 1968, she had helped to found New York Magazine, where she was a political columnist and wrote feature articles. As a freelance writer, she was published in Esquire, The New York Times Magazine, and women’s magazines as well as for publications in other countries. She has produced a documentary on child abuse for HBO, a feature film about the death penalty for Lifetime, and been the subject of profiles on Lifetime and Showtime.
Her books include the bestsellers My Life On The Road, Revolution From Within: A Book Of Self-Esteem, Outrageous Acts and Everyday Rebellions, Moving Beyond Words, and Marilyn: Norma Jean (on the life of Marilyn Monroe), and in India, As If Women Matter. Her most recent book, The Truth Will Set You Free, But First It Will Piss You Off!, was released in October 2019. Her writing also appears in many anthologies and textbooks, and she was an editor of Houghton Mifflin’s The Reader’s Companion To US Women’s History.

Steinem helped to found the Women’s Action Alliance, a pioneering national information center that specialised in nonsexist, multiracial children’s education, and the National Women’s Political Caucus, a group that continues to work to advance the numbers of pro-equality women in elected and appointed office at a national and state level. She also co-founded the Women’s Media Center in 2004. She was president and co-founder of Voters for Choice, a pro-choice political action committee for 25 years, then with the Planned Parenthood Action Fund when it merged with VFC for the 2004 elections. She was also co-founder and serves on the board of Choice USA (now URGE), a national organisation that supports young pro-choice leadership and works to preserve comprehensive sex education in schools. She is the founding president of the Ms. Foundation for Women, a national multi-racial, multi-issue fund that supports grassroots projects to empower women and girls, and also a founder of its Take Our Daughters to Work Day, a first national day devoted to girls that has now become an institution in the US and in other countries. She was a member of the Beyond Racism Initiative, a three-year effort on the part of activists and experts from South Africa, Brazil and the United States to compare the racial patterns of those three countries and to learn cross-nationally. As links to other countries, she helped found Equality Now, Donor Direct Action and Direct Impact Africa.

Moderator

White is responsible for the content across all Conexus Financial’s institutional media and events. She is responsible for directing the bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts, as well as promote the long-term stability of markets and sustainable retirement incomes. She is the editor of conexust1f.flywheelstaging.com, the online news and analysis site for the world’s largest institutional investors. White has been an investment journalist for more than 20 years and has edited industry journals including Investment & Technology, Investor Weekly and MasterFunds Quarterly. She was previously editorial director of InvestorInfo and has worked as a freelance journalist for the Australian Financial Review, CFO, Asset and Asia Asset Management. She has a Bachelor of Economics from Sydney University and a Master of Arts in Journalism from the University of Technology, Sydney. She was previously a columnist for the Canadian publication, Corporate Knights, which is distributed by the Globe and Mail and The Washington Post. White is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program consists of 22 fellows and seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

Robeco chief executive Gilbert van Hassel opened the ‘Sustainability Digital: A Planet in Trouble’ conference with a reminder of the opportunities in sustainability and the importance of working with others. At Robeco this now includes engaging directly with sovereign governments.

Influential investors are increasingly working with sovereign governments on sustainability. In a new initiative, Dutch asset manager Robeco is engaging directly with the Brazilian government on deforestation. The asset manager has held two meetings with Brazil’s vice president and other government members in an investor policy dialogue focused on better implementation of the country’s environmental laws so that companies that break them are suitably punished.

“Brazil has very good laws on deforestation,” said Gilbert van Hassel who has been chief executive at Robeco since 2016. “It is about applying them, and we want to make sure criminal behaviour gets in the courts.”

Speaking during the opening session of ‘Sustainability Digital: A Planet in Trouble’ van Hassel explained that sovereign engagement is now a key tenet of Robeco’s strategy. Working with the PRI, the asset manager is exploring how best to influence sustainable policies at government level: next on the list is Indonesia, where van Hassel plans to engage on deforestation and fires. To encourage other investors to follow, Robeco is drawing up a sovereign engagement framework that will detail which countries to contact and which SDGs to engage on.

“When the policy is ready, we will share it. Engaging with sovereigns is the next level of engagement,” he told delegates.

The CEO urged attendees of the two-day digital conference to embrace the complexity of sustainability. This means grasping the many different angles to sustainable investment, extensive research and not “pushing away” from the challenges. Partnerships and acting in unison are also central.

Above all, he urged for less talk and more action to reverse climate change, calling on investors to integrate ESG into their investment decisions and look for outcomes and financial gains that also create wellbeing which he called “as important” as wealth creation.

“If we embrace complexity and act together, we can reverse these trends. As investors we really need to stop talking about these issues and start acting. It has to be mainstream, and it has to have scale,” he said.

Action should include investing in sustainable companies and divesting from unsustainable companies, as well as finding innovative ways of investing in sustainability by evaluating a company’s contribution to ESG.

“Companies that make progress on ESG should have access to the capital markets,” he said. In a next step investors need to measure and report impact “in a whole different game.”

Opportunities

He also espoused the opportunity sustainability holds for investors. Despite the frightening evidence of the consequences if the natural world can no longer support humanity, he said it also presents opportunities that are clearly enshrined in the UN’s SDG.

“The issues of the future are no different,” he said. Of the 17 goals he said climate, labour rights and inequality are mentioned most by Robeco clients.

“In the next 10 years there will be tremendous innovation to ensure we reverse the trend,” he forecast.

Partnerships also lie at the heart of Robeco’s sustainability strategy. Alongside working with sovereign governments and the PRI on how best to influence climate policy, the asset manager has partnered with others to bring about change at oil giant Shell, and also works with universities like Cambridge and Erasmus. And partnerships with clients on appropriate strategies are another central seam. Most recently this has included looking at ways to use clients’ risk budgets to ensure portfolios have better ESG integration than the index, or put another way, using the risk budget not to deviate from the index.

“Alone is alone, together is more powerful,” he says.

He concluded by saying the asset manager’s offices remain closed, with long-term consequences on culture, innovation and employee connection worrying and unknown.

“It is much better to sit and work together,” he said. “We will only see what the consequences are in the long-term.”

Investors from Schroders, Trillium and PensionDanmark discuss how a changing regulatory picture and the economics of sustainable investment are coming together to create a tipping point in ESG, but they warn their peers to look beyond the label to what is on the inside.

In keeping with being one of the first investors in wind energy years ago, Denmark’s PensionDanmark was also an original investor in the country’s state of the art energy island in the North Sea. Matching the energy output of 25 traditional wind farms, the island is one of two recently ratified by Parliament with the promise of transforming Europe’s energy sector.

“We are on the brink of the next step in offshore wind development,” enthused Torben Möger Pedersen, chief executive of Denmark’s PensionDanmark speaking at ‘Sustainability Digital: A Planet in Trouble.’

“I encourage colleagues in the pension fund industry to be aware,” he said, espousing the risk-adjusted returns that will come from investing in the pioneering infrastructure that connects to the grid and will see green power integrated into transport systems.

In a panel session chaired by PRI’s chief executive Fiona Reynolds, Pedersen also highlighted the investor opportunity in the EU’s giant €750 billion stimulus plan, around 30 per cent of which will go towards green endeavour. “Thirty per cent is linked to investments in the green transition and climate-related projects. Most of them will be a source of interest to private investors,” he predicted, adding that the pension fund has been involved with the EU on shaping the taxonomy that will introduce common standards on ESG and which is designed to stop green washing.

Elsewhere he said the pension fund is focused on engagement over divestment and is a proud founding partner of the Asset Owner Alliance under which it targets a carbon neutral portfolio by 2025. “Members of the Alliance have reduced their carbon footprint. If you can’t fulfil targets, you can’t be a member.”

Sustainability policy in 2021

Policy is having a mixed impact on driving sustainable investment.

Although panellists highlighted progress under the EU’s sustainable finance bill, policy in the UK is evolving in “fits and starts” according to Sarah Bratton Hughes, head of sustainability, North America at Schroders. However, she predicted initiatives will ramp up ahead of COP26. Elsewhere she noted Brazil’s plans for a taxonomy.

But it is the US where most change is afoot.

“We are not the black sheep on the team anymore,” said Bratton Hughes who is based in New York.

Department of Labor rules, introduced at the end of last year under the Trump administration, have discouraged pension plans from considering ESG issues when choosing investments. Bratton Hughes told delegates the rules had thrown a “cold shower” on ESG progress with some pension plans stalling sustainability searches although she noted “others have ploughing forward.” Now however the hope is Marty Walsh, Biden’s labor secretary, will overhaul the rules.

Fellow panellist Matt Patsky, who is chief executive of Boston-based Trillium Asset Management told delegates that getting US public sector pension funds on board with ESG would require a rewriting of the rules.

“Pension funds need to see they are “violating” their fiduciary duty if they ignore ESG, and that ESG improves alpha. The government should edit the rules to be factually correct and put every plan on notice that they are in violation of fiduciary duty if they don’t consider these factors,” he said.

In other encouraging signs of change, Patsky told delegates that his firm is seeing a broad shift into ESG from traditional investment firms, notably on a portfolio-wide basis rather than via isolated ESG products. He said he hoped regulation would increasingly put pressure on companies to report on ESG and said more standardisation highlighting what and how companies should report on ESG is now crucial.

“This is the critical next step for real momentum,” he said. “Everyone looks at ESG data as material. This year and next we will hopefully see movement towards broad adoption and agreement on these standards.”

The conversation also centred on the importance of impact, whereby the externalities of an investment are measured and seen as material to future earnings.

“Impact is a third dimension and we need to measure and manage that risk,” said Bratton Hughes, adding Schroders integrates impact via engagement and stewardship, and providing investment products to measure the real world impact.

Meanwhile PensionDanmark is integrating the impact of its investments relative to the SDGs.

“We measure our outputs; how we are impacting healthcare provision or equality,” said Pedersen. He also said it was important pension funds explored alternative investments, and underscored the move from listed to private assets.

“As long as interest rates are kept low we see opportunities in listed stock markets, but stock markets will be challenging for the next few years. Increasing allocations to non-listed assets is our way forward.” Pedersen said.

Bratton Hughes told delegates that the economics of green power do work and is superior to legacy fossil fuels. This, combined with regulation, gives her reason to believe the world is at a tipping point. Citing MSCI’s data that tracks regulation, she said the amount of regulation is sharply increasing.

“If you looked in 2018 there were about 100 regulatory polices, that’s now doubled,” she said.

Patsky concluded with advice to investors to pay attention to what they are investing in – cautioning against chasing labels but looking carefully at what is inside.

“Be willing to be sceptical,” he advised. “Ask if this is really sustainable.”

“In order to be successful we need every owner to be active and behave as an owner. A big part of change is a realisation of the power of ownership and its opportunity.”

With great power comes great responsibility. As institutional investors exercise their power to invest their clients’ money, they have a responsibility to act as stewards of the capital. Stewardship does not end with buying or selling a stock, but includes the engagement by institutional investors with publicly listed companies to generate long term value for shareholders. Such engagement increasingly requires consideration of environmental, social and governance (ESG) issues.

As put forth in the CFA Institute report titled “Stewardship 2.0: Awareness, Effectiveness, and Progression of Stewardship Codes in Asia Pacific” published in 2020, stewardship is vital to the healthy functioning of markets, supports market integrity, improves capital allocation, and helps deliver good outcomes for clients and ultimate beneficiaries.

The 2008 global financial crisis threw the need for engagement into sharp relief. By acting as responsible stewards of capital, and by addressing company underperformance, institutional investors can check and curb short-term behaviours and excessive risk taking. This was especially pertinent in the UK where it gave rise to the first regulatory-backed stewardship code in 2010.

The adoption of the first Stewardship Code in the UK inspired a number of other markets to follow suit. In Asia Pacific, at least nine markets have since established their own codes to encourage institutional investor engagement.

While the codes share many similarities, such as the requirement to establish and disclose a stewardship policy and a conflicts of interest policy, each market has its own unique objectives. The main driver of the UK code was to prevent a recurrence of the banking crisis, but in Japan, for example, the motivation was to reduce the equity market discount by placing an emphasis on shareholder value creation.

Despite their short track records, stewardship codes have already been getting makeovers to reflect new  challenges. While the focus to date has largely been on disclosure of voting and engagement policies, there is a move toward disclosure of voting records, and disclosure of reasons for such votes. Disclosures of conflicts are also high on the priority list.

One notable trend is in the elevation of sustainability and ESG issues on the stewardship and engagement agenda which encompasses not just voting but also active, constructive dialogue between investors and their companies regarding sustainability and ESG themes. By encouraging companies to pay greater attention and provide more information on material ESG issues, these companies would be better positioned to deal with such challenges and improve their performance, which in turn, would help value creation for shareholders. This is also in-line with the Principles of Responsible Investment in which signatories pledge to be active owners and incorporate ESG issues into ownership policies and practices.

This heightened attention of ESG issues is being reflected in several code upgrades.  The updated 2020 UK Stewardship Code, for example, asks institutional investors to take ESG factors, including climate change, into account and to ensure their investment decisions are aligned with the needs of their clients. In Asia Pacific, similar upgrades took place in 2020 in Japan and Taiwan. Codes in Australia, Malaysia and Thailand also emphasise the importance of ESG factors.

While engagement and monitoring are worthwhile activities, they must also be outcome-oriented and serve a clear purpose. In the past, it may have been sufficient for institutional investors to pay lip service and report on a list of stewardship activities, without drawing attention to how effective those activities were, and how fiduciary duties were fulfilled.

However, as expectations evolve, there is a growing desire for clients to understand better how their money is being invested. The institutional investors which are most advanced in this space undertake thorough research to identify those companies that have the most potential, set well-defined objectives and measurable targets for their engagement activities, and would report to clients the outcomes of their efforts as well as revised action plans, where appropriate. This is effectively a multi-stage, iterative process. In the event that constructive engagement does not deliver the desired outcomes, escalation measures may be considered, including, for example, collaboration with other investors, and even divestment for active investors.

As a result of these trends, adjustments are being made to operating models. Some institutional investors have supplemented their bench strength by hiring dedicated ESG analysts or by providing relevant training to raise the level of knowledge in the investment teams. While there is no one-size-fits-all approach, it is important that the investment professionals stay current and remain effective in this important area.

As sustainable investing continues to gain prominence, so is the expectation of institutional investors to exercise their stewardship for purposeful outcomes. The focus is also shifting from the amount of engagement to its quality. This presents a unique opportunity for institutional investors and companies to elevate the way they engage and create long term, sustainable value for shareholders.

Mary Leung is head of standards and advocacy, Asia Pacific for CFA Institute.