Let's call a spade a spade: A plea for accountability

Inflection Points

Let's call a spade a spade: A plea for accountability

Can we speak frankly? In my humble opinion, the single greatest threat or impediment to environmental nirvana is not a runaway, frack-happy oil and gas industry, or the depredations of companies in the mining, forestry, or other high-impact sectors.

Nope. We have seen the enemy, and it turns out to be us.

More precisely, it is our seemingly endless capacity to either practice or tolerate self-delusion and hypocrisy on the part of the most important single group of actors in the push for global sustainability: the institutional investors and those who "serve" them (generally, unfortunately, it's the other way around, but that's a discussion for another day). Pension funds, foundations and endowments, mutual fund providers and hedge funds are far and away the most critical providers of financial oxygen to the major companies that are largely determining environmental and social outcomes on the ground. As a direct result, big investors' priorities very quickly become priorities for corporate boards and senior executives as well. For the past millennium or so, in practice, that has created at least two key priorities for corporates:

  • maximizing short-term profits, whatever the costs to the long-term viability and value-generating capacity of the company; and
  • ignoring, to the greatest extent possible, the environmental and social impacts the company might create, viewing any investment in improving their performance in those areas as an unmitigated drag on profits.

Investors, in turn, have generally regarded any investment by companies in improving their environmental and social performance as either fundamentally irrelevant to their financial returns (on a good day) or, more frequently, a drain on both the company's and their investors' financial returns.

My basic point is this: As long as these attitudes persist among major investors, substantial improvements in companies' sustainability performance will remain elusive and fragmented at best. And when you boil it down (and this usually gets lost in the commercial shuffle), "the investors" are, in fact, us! They're playing with our money: our pension savings, mutual fund investments, charitable contributions and so on. And if we're actually serious about comprehensive, systematic improvement in global environmental conditions, we must change — fundamentally — the basis upon which trillions of dollars (and euros, francs, renminbis, yen, kronor, and dinars) are invested in companies.

The good news, we are assured, is that all this is now changing dramatically. Investors are apparently experiencing a collective enlightenment that makes the Renaissance look positively small-time and retrograde by comparison! After all, isn't the Carbon Disclosure Project now supported by over $70 trillion in investable assets? The UN Principles for Responsible Investment, an even more tightly focused initiative, is a relative charity case with a paltry $32 trillion worth of investable assets solemnly pledging to integrate sustainability considerations directly into their investment processes.

Next page: Has sustainability nirvana arrived?

So sustainability nirvana has arrived, right? The great engines of the capital markets are now focused like lasers on ensuring that the companies in which they invest are veritable paragons of sustainability, correct?

Well, not so much.

My own personal, back-of-the envelope estimate is that less than 5 percent of the UN PRI signatories are coming anywhere close to doing what they say — that is, meeting their commitments. Yes, there are exemplary leaders showing the way: APG and PGGM in the Netherlands, the U.K. Environmental Agency staff pension fund in Britain, CalPERS and CalSTRS in California, for example.

But where are the rest? Where, for example, are the huge staff pension funds of both the World Bank and the United Nations? (Yes, that's the very same UN that promulgated the Principles of Responsible Investment). I would argue that very few staff members of either organization are violently opposed to improving environmental and social conditions, and it is their money, after all! Where are the sovereign wealth funds — long-term investors if ever there were ones? With the conspicuous exception of the Norwegians, they are — well, nowhere.

And what of the foundations? The big ones must, by law, give away 5 percent of their assets every year, and many have made wonderful contributions to the environment, social justice, education and training, poverty alleviation, and so on. But what about the other 95 percent? Since you asked, I'll tell you. With the exception of a few small, plucky U.S. foundations such as Skoll, Heron, Noyes and others you've probably never even heard of, they invest the other 95 percent of their assets exactly the same way as everybody else does — with zero systematic regard for environmental or social impact. For all they know, their investment activities are actually undermining the good work they're doing on the other, grant-giving side of the organization. If they're reinforcing their program objectives by aligning their investment strategies, it's purely by accident. Yes, it's true that some leading foundations have programs for so-called "mission-related investment," but they generally represent only a trivial portion of the organization's assets.

This is a tragic waste of resources and leaves an untold amount of positive impact on the table. Oh, and by the way, it also deprives the organization of the improved risk-adjusted financial returns that both academic research and actual experience suggest are available to those who choose to look for them

How, you ask, can this possibly be? The problem at the root of all of this is one of behavioral finance. Its proximate symptoms are a lethal combination of:

  • nearly ubiquitous career or "maverick" risk-aversion — no one wants to risk ridicule or firing for trying something new
  • stultifying inertia, both individual and organizational
  • the complete absence of systemic incentives that might actually encourage a lot of innovation
  • a vast conspiracy of silence and/or self-delusion by the most powerful players in the investment management food chain

Privately, and especially after a few glasses of chardonnay, knowledgeable pension fund and foundation consultants, trustees, and asset managers alike will readily concede that adding an analysis of companies' exposures to sustainability risks and opportunities to traditional financial analysis can, at a minimum, enrich the analysis and, on occasion, help identify both risks and opportunities confronting companies that could materially affect their financial performance.

Indeed, many of the aforementioned have even written articles to that effect. The problem, sadly, lies not in what they say, it's in what they actually do.

When it comes time for the rubber to meet the road and money is actually invested, a rather different reality emerges. In practice, in the real world outside the sustainability and SRI conference halls, the odds are stacked prohibitively heavily against innovative or "unconventional" investment strategies and approaches. (One might at this point innocently inquire just how well the conventional ones have worked out in a world where two-thirds of the money managers routinely under-perform their benchmarks, but perhaps that would be churlish.)

My occasional colleague, professor Joe Stiglitz, won a well-deserved Nobel Prize years ago for his research and insights on "asymmetrical information." He argued convincingly that not all participants in financial markets are operating with equally complete information, nor do they always receive that information at the same time. Seems a rather quaint insight in the insider trading, post-Occupy Wall Street world of today, doesn't it?

If I could borrow Joe's "asymmetrical" insight for just a moment, I think it can shed some light on our current conundrum.

It's instructive to note the vastly asymmetrical incentives which obtain throughout the contemporary investment food/value chain: pension fund and foundation trustees, consultants and money managers alike have virtually no incentive to innovate! Where's the upside for them? If they follow the herd, and simply do what all their peers do, there is virtually no downside risk if it all goes wrong — even badly wrong. (See: global financial crisis, as well as Keynes, John Maynard: "failing conventionally").

If, on the other hand, they stick their necks out and become the first to try something "untested," the punishments for "failure" (and Lord knows, conventional, time-tested approaches almost never fail, do they?) are exponentially larger and more unpleasant than whatever meager plaudits and rewards might await a bold innovator on the upside if it succeeds. So why would any rational, non-masochistic person take the chance?

What's to be done? If — if —there is a way to be found out of this quagmire of self-reinforcing inertia and stultifying orthodoxy, it lies in our own hands. Can we summon the intellectual and interpersonal courage to call a spade a spade?

I believe that we need to bring ourselves to challenge those to whom we've entrusted our retirement savings, charitable donations and tax payments to do at least three things:

  • First, acknowledge that this is indeed the 21st century, and their investment approaches should explicitly and systematically acknowledge that fact. That means sustainability integration, period.
     
  • Second, match their high-minded rhetoric about sustainability with concrete actions, and start providing investment strategies and solutions for their clients (us) which genuinely give voice to them.
     
  • Third, don’t sit idly or quietly by the next time you hear patently ridiculous claims made publicly about how frequently and thoroughly sustainability considerations are being integrated into various investment processes and strategies. (I could give you hundreds of examples, but hope to live to at least a moderately old age in reasonable health). Collective silence only reinforces the disingenuous, and militates mightily against progress.

If we can somehow manage, against all odds, to do that, we stand better-than-even odds of leaving our children and grandchildren a viable planet. The stakes are pretty high.

Image of businessmen with currency signs by Tom Wang via Shutterstock