Mainstreaming Responsible Investment - AccountAbility

Executive Summary
from the electronics companies of Silicon Valley to the oil wells
of Nigeria, millions of citizens are the beneficial owners.
Most individual participants in pension plans, mutual funds,
and insurance companies are investing to provide for their
retirement or other long-term financial needs. In this sense, the
widespread benchmarking within the fund management
industry against short-term performance benchmarks that fail
to take account of social, ethical, and environmental aspects
of corporate performance is increasingly out of step with
underlying client interests. Social and environmental factors
can be quite significant drivers of longer term financial
performance, particularly through their influence on the
enabling environment for business operations and investment.
In the long run, the vitality of markets is influenced greatly by
prevailing legal, regulatory and macroeconomic conditions,
which ultimately reflect policy — i.e., political — choices made
by democratic societies. While a serious problem or major
opportunity associated with the environmental or social
performance of a particular business model may not manifest
itself in the short term, it may well show up in financial results
and market valuation over time as consumers, regulators,
voters or plaintiffs lose confidence and respond accordingly.
Investment is first and foremost about meeting the needs of
the owners of capital. If the real owners of most of the capital
in today’s markets are mainly the intended beneficiaries of the
pension funds, mutual funds and insurance companies, then
the responsibility of these investors will increasingly be to meet
the intrinsic interests of pension plan participants and
insurance policyholders in not only competitive near-term
returns, but also the long-term vitality of their countries’
economies, societies and environments. This will require the
deliberate incorporation of material social and environmental
aspects of corporate performance in investment analysis and
decision making, grounded in:
1) full appreciation of the rights and long-term interests of the
ultimate beneficiaries of funds that typically have very
long-term liabilities; and
2) broad understanding of the factors, such as social and
environmental considerations, that could influence returns
over the long term.
In this important sense, it is the transformation of share
ownership by rapidly aging populations in most industrialized
countries that is fundamentally altering our conception of
responsible investment and potentially driving it into the
mainstream financial community, in ways that the founders of
the original SRI funds might not have imagined possible.
The Systemic Nature of the Challenge
That the investment value chain (e.g., pension/mutual funds,
advisors, asset management firms, analysts, etc.) as a whole
does not factor in social and environmental issues is not most
usefully understood in terms of the personal values of its
participants. It arises because of today’s blend of available
information, participant competencies and, most of all,
institutionalized incentives that drive behaviour. These factors
combine in creating the perception that significant competitive
disadvantage will befall any one player that strays from
customary practice. That is, the development of responsible
investment is impeded by a classic “prisoner’s dilemma” in
which it is in no one’s interest to take the first step alone in
making changes, notwithstanding that all players could
benefit.
Fund managers point to the role of their clients in driving their
focus on short-term performance. As one fund manager
argued, “As long as client [e.g., pension fund trustees]
mandates require us to deliver performance benchmarked
against short-term market tracker indexes, we will of course
remain short-term in our outlook.” Analysts, similarly, argued
that they could rarely advance social and environmental
performance issues so long as their clients, fund managers,
were only concerned with drivers of short-term performance
and market valuations. One analyst summarized his
experience thus, “Strategic research on future social and
environmental risks and opportunities got me my five minutes
of fame. But there were no buyers for the work, and this is
what counts at the end of the day. Given the choice again, if I
want to stay in business, I would not do such research.”
Such behaviour in financial markets has a tangible impact on
the real economy. One extensive study found that, “Because
of the severe market reaction to missing an earnings target,
firms are willing to sacrifice economic value in order to meet a
short run earnings target…. The preference for smooth
earnings is so strong that 78% of the surveyed executives
would give up economic value in exchange for smooth
earnings.… We find that 55% of managers would avoid
initiating a very positive [Net Present Value] project if it meant
falling short of the current quarter’s consensus earnings.”
Specific Impediments
Following are some of the most salient impediments to
broader consideration of non-financial factors by the
mainstream investment community, identified by the project’s
three roundtable discussions and further developed in
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