What a decade this was.

Filled with missed risks and misrepresentations, from Enron to credit default swaps, through rogue traders at Societe Generale to Tiger Woods, from internet and real estate asset bubbles to Worldcom, not to mention two wars, ongoing terrorist threats and on and on. That’s some of the bad news. The good news, of course, is that sustainability has risen as a methodological context that can guide us towards corporate and personal behavior that can lead us out of this age of excess and bloat, into a new age of managed growth & success. Of course, the other bad news is that science tells us that we are reaching the limits of environmental patience with our extractive ways. Again, the good news is that turning to sustainable practices is the way out. And so what does this mean for investors?

On the one hand, normal, mainstream investing, not surprisingly given all these minefields, has not performed well through this period. The S&P 500 is down for the decade just past, after a long, slow procession of upward movement for decades prior. Ten years starts to become a significant period of time to examine and consider. This, combined with the excellent recent performance of the BRIC (Brazil, Russia, India, China) markets, which have provided the outperforming funds of the last 5 years by far, focusing especially on China and Latin America, and we enter a world where the US is no longer the world’s single economic superpower. Rather, we are now one of three dominant regions, along with Europe as a whole, and developing nations (which unto themselves splinter into two blocs -- BRIC and the G77 -- as seen at Copenhagen). And so we now enter an increasingly competitive world, where innovation and education will drive future success.

Looking at the investment philosophies of the majority of assets under management in the United States, it is clear that there is a desire for business as usual, but this desire is not matched by this new global reality at hand.

We last wrote for GreenBiz.com on our vision of Sustainability 2.0, whereby sustainability can be seen as a contemporary risk factor across ESGFQ (environment, social, governance, financial (mainstream) and quality of management) factors, each of which can take away from the investable nature of companies. Combining this with using sustainability as a way of finding opportunities through innovation, and you start to develop a winning investment formula.

Yet looking at the largest fund managers, the so-called experts, including theoretically long-term investors Fidelity, Vanguard, TIAA-CREF, State Street, BlackRock/iShares, Capital Group, Wellington, AllianceBernstein, etc., and little to no focus goes on sustainability from an investment standpoint at these firms.

Rather, these investors as a group seem stuck on investing methods that brought them success, but in a very different world that we are now leaving behind.

And this is just a list of those who focus on long-term returns, or are supposed to. Hedge Funds and Quantitative investors beyond that, also do not largely factor in sustainability in investing, nor do sovereign wealth funds by and large.

Why is this the case? A generation of financial success, at least before the recent crisis, combined with built-in relationships and high fees is part of the explanation, but also the fact that sustainable investing is not well understood also clearly does not help.

All Things Considered
Sustainable Investing, as we wrote about for our book Sustainable Investing: The Art of Long Term Performance, and as reiterated in our recent UN PRI Academic Conference paper, represents an investment discipline that explicitly considers future social and environmental trends in financial decision making, in order to provide the best risk-adjusted and opportunity-directed returns for investors. By anticipating these trends ahead of the market, sustainable investing seeks to identify ‘predictable surprises’ that can help ensure shareowner value over the long-term.

This is in sharp distinction from the first wave of SRI (socially responsible investing) that is more values-based than focused on value (also see the UN PRI Academic Conference paper from Watson Wyatt for more on this) and has not led to outperformance. Classic SRI practice remains the largest block of SRI assets, hence the somewhat understandable meme that has risen that you can’t make money if investing to your morals. Yet other studies, such as ours, as well as Matthew Kiernan’s recent book, and studies from the more forward looking fund managers in Europe such as Robeco, show consistent outperformance from factoring in sustainability.

In our view, sustainable investing remains the investment opportunity of the coming decade, which, if switched to en masse, would unto itself create a race for capital among companies that would also ensure the innovations and efficiencies that the world now clearly requires. All good news.

As per our book above, we took a look at sustainable investing in practice on a global basis, and found outperformance for the 1, 3, and 5 years leading up to the end of 2007 vs. mainstream indices, and so in effect before the recent crisis.

Likewise, for the UN paper presented in Ottawa this fall, we found outperformance for the 5 years leading up to the end of 2008 (though 2008 was disastrous unto itself for all equity investment of course) as well as in the first half of 2009, and so before, through, and after the crisis, sustainable investment as a philosophy has begun to truly emerge.

Building a Sustainable Portfolio
And so, this past fall, we set out to teach the first half of a course within the finance track of the CERC (Center for Environmental Research and Conservation) unit of Columbia University, to discuss how one could best fuse the risks and opportunities inherent from aspects of sustainability into investing, with the overall goal of the class to build, interactively with students, a most sustainable portfolio. We believe this class’s positive focus on sustainability as an investment factor represented the first time a class like this has been given, which we are proud of, and thanks to CERC & Columbia for providing us with this platform, and especially to the students who contributed so much to the process. We hope to see other learning institutions follow suit.