3D framework a game changer

The 3D investment framework is a game-changer for all of us

In 1995 a Goldman Sachs research report provocatively suggested that 20 to 25 global super firms would come to dominate the asset management industry, leaving some room for niche specialists but not much for mid-sized firms. It struck a loud chord at the time, particularly as investment firms were pretty local and fragmented – for example BlackRock, Mercury Asset Management, Merrill Lynch and BGI were all separate. Asset owners were not dissimilar in this respect too.

As it turned out, it was a strategic inflection point when a number of asset management firms embarked on a global transition, but the change proved not quite as dramatic in the concentration and consolidation forecast. That was largely because the asset owners, retail clients and regulators weren’t on the same journey.

But the era of truly global firms emerging was a game-changer where such firms became multi-faceted global organisations in location, strategy, culture and reach and usually shaped by the effective combination of four factors:

• Similar global product around the world
• Equal instantaneous access to quality research
• Leverage of global talent to service local clients
• Global culture that rewards global teamwork.

This combination has been a big growth engine for those firms that ticked these boxes.

Roll forward 25 years and I believe we are at another strategic inflection point of at least the same significance.

This time it’s about the sustainability transitions of both investment firms and asset owners. This transformational change is being driven by the slow moving but unstoppable ESG train, which is now rapidly picking up pace because of climate issues and the Paris Agreement. Sustainability is effectively funnelling together ESG, impacts and longer-time-horizon thinking to challenge our existing investment models.

And while mindsets are shifting faster than I have seen in my career so far, most investment organisations are struggling to know how to adapt.

The so-called Race to Zero is an example, where big investors are the latest to join this global campaign to support a healthy, resilient, zero-carbon economy and build momentum around the shift to a decarbonized economy ahead of COP26.

These asset owners and asset managers are doing so largely to align with nationally determined contributions from governments responding to the Paris Agreement. These net-zero-transition commitments require significant and transformational pivots by investment organisations. But a number of both asset owners and asset managers such as BTPS, HESTA, PGGM, AXA, Generation IM and Robeco are part of a growing band that have heeded the call using focused investor groups like Net-Zero Asset Owner Alliance and Net Zero Asset Managers initiative.

In the short term this ratchetted pressure will support low carbon transitions, but the game-changer will come when institutional investing morphs into three-dimensional (3D) investment frameworks and mandates, that integrate impact with risk and return.

Traditionally impact, within the ESG approach, was linked to better investment outcomes. Where investors aim for the financial benefits of tilts into the ‘good’ companies while society and the planet get only difficult-to-define, second-order gains. This approach to impact gives end investors some reassurance that what they hold is better than the alternative and may be making a small societal contribution but probably won’t change the world.

In the context of increasing ESG ambition, this approach looks ‘lite’ compared to emerging ‘full’ impact strategies which intentionally target positive societal and environmental effects with the associated measurement to demonstrate the additional real-world effects. This approach is referred to as the universal-investor strategy and can be traced back to big asset owners like GPIF. These highly innovative strategies emphasise building better beta through active ownership and engagement as much as allocation strategies to achieve the real-world impacts without sacrificing risk-adjusted returns.

So how will this strategic transition be different to the last? This time the scale advantages are bigger (with more beta emphasis over alpha) so the emergence of 20-25 ‘truly sustainable firms’ and a similar number of asset owners that are quite dominant in their universal-investor strategies seems more likely.

This is premised on three-dimensional thinking and mandates becoming a source of growth for the industry, led by retail and wealth, with a narrower base in institutional broadening out with trickle-down to other funds over time. The Race to Zero will accelerate take up of these mandates as will the smouldering platform for sustainability change, which is shifting mindsets all the time.

Which investment organisations will become the truly sustainable super firms of the future? I think it will favour organisations that are collaborative – with research relationships across wider fields (like climate change), data relationships, distribution relationships and index provider relationships (with index strategies embedding a bigger slice of the industry intellectual capital). It will certainly also favour those organisations that manage to evolve the highly imperfect ESG data sources into decision-useful forms via effective data governance and culture.

Similar to the globalisation transition of yesteryear, the sustainability transition will also depend on the excellence of organisations in their product innovation, research, talent and brand, and culture with these likely features:

• 3D frameworks – strategies and mandates that convincingly balance risk, return and impact
• Innovative research, thought leadership and effective engagement on ESG and impact
• Leverage of talent and brand to connect and engage key stakeholders
• Culture that rewards purpose and sustainability thinking

Where product innovation was the lead factor in the globalisation transition, the sustainability transition will depend most on organisational culture. We see it not only as the key catalyst to launch the sustainability transition, given its link to purpose, innovation, collaboration, resilience, integrity and transparency but also the most logical change lever for leadership to use. The quantum of change needed to become the truly sustainable firm is large, which is also why only the strong-cultured seem likely to make the transition successfully.

In a world looking for stronger leadership and from an industry striving for greater purpose the 3D investment framework is game-changing for the world, the investment industry, and each of us personally. At a time when we need silver linings here is one.

Roger Urwin is co-founder of the Thinking Ahead Institute