Mainstreaming Responsible Investment - AccountAbility

An Investment Management Perspective
Where We Are
Among other things, the roundtables made clear that
“responsible investing” remains a niche in the fund
management industry today (within strict parameters of the
definition of “responsible investing” in this paper, for certainly
no asset manager would claim to do the opposite). Admittedly,
there are pockets of activity focusing on specific themes (such
as the Calvert Group in the US), or approaches (such as
Hermes Investment Management in the UK). However, for
mainstream asset managers, the most common and explicit
form of responsible investing involves pre-investment nonfinancial
screening of the universe of opportunities, in
compliance with precise guidelines from clients. In addition,
active managers typically will also consider the impact of
companies’ business models, and their managements’
approach and track record, regarding social and
environmental issues, so long as the analysis is material to
their financial performance within the foreseeable future. The
extent to which this type of analysis is performed varies
tremendously from one asset management company to
another, driven by differences in philosophy, investment time
horizon, propensity to take risk, degree of benchmark
orientation and depth of skilled resources. Stated differently,
fund managers’ interest in and motivation to consider
responsible investment criteria — except to fulfil clients’
explicit directions (in which case pre-investment screens are
used) — stems from their competitive desire to outperform
relevant benchmarks and peers, towards which end they will
typically bring to bear all relevant information and analysis, so
long as it is material to performance and likely to be
recognized in the marketplace within a time period consistent
with their clients’ investment horizons. Despite the competitive
urge to outperform using all possible means to generate an
investment “edge”, the use of responsible investment criteria
in day-to-day research and portfolio decision-making remains
an exception rather than the rule, driven to a large degree by
the inertia of practices and standards that have come to
dominate the industry over time.
Regulatory Environment
The objective of responsible investment is complicated by the
reality that we live in a world with little disclosure about the
long-term impact of corporations’ social and environmental
policies on their businesses. This lack of disclosure is further
compounded by the lack of industry standards by which such
long-term liabilities of uncertain magnitude can be
incorporated into traditional approaches to financial analysis.
Consequently, the link between companies’ long-term social
and environmental practices and their short-, intermediate- or
even long-term financial performance generally tends to be
unclear, with the exception of current activity (such as
litigation) that falls within extant definitions of “materiality”.
On the other hand, it is no surprise that the fund management
industry has grown up with explicit rules governing every
aspect of their activity, given the highly regulated nature of the
business. As a result, the parameters within which a fund
manager can invest clients’ assets are strictly defined, and
those definitions tend to be interpreted in the narrowest
construct of financial returns and risks consistent with clients’
investment time horizons. Fund managers need to act in
demonstrable compliance with the performance objective of
optimizing clients’ financial returns, which is typically defined in
their contracts relative to certain benchmark indices, at
specific levels of risk, and/or with respect to pre-defined peer
groups. The need for demonstrable compliance creates a
burden of proof on the part of the fund manager, which at best
heightens managers’ sensitivity towards risk-taking and at
worst encourages inertia around “tried and true” approaches
that are easily defensible. This high level of regulatory
awareness and scrutiny, combined with the widespread use of
benchmark indices and clients’ gradually shortening time
horizons for performance evaluation, is a powerful driver of
conservatism among fund managers with respect to
innovation. Therefore, in the absence of some combination of
greater disclosure on the part of corporations regarding the
long-term business impact of their social and environmental
policies and wide acceptance of metrics by which such longterm
liabilities are valued, the industry standard of
demonstrable compliance is likely to remain a significant
hurdle to mainstreaming responsible investment.
Fund Manager Evaluation
The science of performance measurement has undergone
revolutionary change. The introduction of Harry Markowitz’s
Capital Asset Pricing Model 60 (CAPM) helped establish the
concept of a “market portfolio”. Over time, the combination of
insights from CAPM, further refinements thereof and, in
particular, the often misused work on asset allocation by
Brinson et al., 61 catalysed the propagation and in some cases
creation of a myriad of benchmark indices covering almost
every asset class, geography, market capitalization and style.
The language of asset allocation quickly became the standard
for discourse in the industry, leading to rapid, widespread and
systematic implementation of index-oriented performance
measurement for fund managers. Today, these indices are
ubiquitous, so much so that what began as a means of more
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