Responsible investment is one of the biggest investment trends of the 21st century. In part, this is driven by the realisation that the world around us is changing rapidly. Food, water and energy security, natural resource scarcity, climate change, human rights, labour standards and demographic change have all become material issues for companies, while the financial crisis highlighted the need to foster long-termism within financial markets and improve the alignment of interests across the investment chain. Investment policies and processes now need to evolve to capture a broader range of risks and opportunities, over longer periods of time, than ever before.
Fortunately, a global network of like-minded organisations trying to figure out what all of this means for investment risk and return already exists. Supported by the United Nations, the goal of the Principles for Responsible Investment (PRI) Initiative is to increase understanding of the relevance of environmental, social, and governance (ESG) issues for the investment community and encourage investors everywhere to be more active owners of the companies in their portfolios. By implementing the PRI’s six Principles and putting responsible investment into practice, some 1,200 signatories to the PRI around the world are at the forefront of creating a more sustainable financial system and helping to prevent the next financial crisis. Never before has the role of the investor in creating an enabling environment for the growth of a sustainable economy been so important. And that’s why, earlier this year, I took up the post of Managing Director at the PRI in London.
On many measures, the PRI has been very successful since its launch in 2006. Signatories manage combined assets of USD $34 trillion, or nearly one-fifth of global capital. It has greatly increased the level of transparency around the activities and capabilities of its signatories. In 2011, nearly 550 of them completed the PRI’s annual reporting and assessment survey outlining how they are putting the Principles of ESG incorporation, active ownership, transparency, collaboration, and disclosure into practice. It has also fostered greater collaboration between investors and supported their engagements with companies and policymakers on ESG issues on a scale simply not possible before. Over 2011/12 alone, signatories contacted more than 1,300 companies via the PRI’s clearing house platform to encourage them to improve their performance or disclosure on ESG issues.
Australian investors are naturally very attuned to environmental and social issues and it should come as no surprise that the PRI’s Australian network, managed by the Australian Council of Superannuation Investors (ACSI), is one of its largest and fastest growing, with 125 signatories and counting. One quarter of these are superannuation funds, so yours may be among them.
Despite this progress, there is still a long way to go before responsible investment can truly be considered mainstream. We know that the way the market currently works, through the investment chain from asset owners via investment managers to companies, does not always serve the true long-term interests of the millions of ordinary Australians who save through super funds or insurance products. The financial crisis gives the responsible investment community an opportunity – indeed a responsibility – to address sustainability challenges more strategically than it has done to date.
The responsible investment community needs to lift its sights and become more engaged with the nuts-and-bolts of the investment chain, the portfolio-wide implications of ESG externalities, and the stability and health of the market as a whole. Portfolio turnover, performance monitoring periods, benchmarks, fees and real long-term alignment of interest between asset owners, asset managers and companies all need to be part of responsible investment’s territory.
To inform this re-tuning of the investment chain, we need to understand far better how long-term externalities and market failures such as climate change will impact whole portfolios, across asset classes, and how investors can respond. The objective here is to ensure that the whole investment chain is focused consistently on long-term value creation. This should ensure that far greater account is taken of environmental and social sustainability issues than at present.
We also need to explore how far it is in investors’ financial interests to encourage policy action to bring externalised sustainability costs on to companies’ books. For some years now investors have supported strong government action on climate change. We need to strengthen work on climate change, and explore applying the same principle to other issues. All this will not in itself change investors’ fundamental objectives, but it will significantly increase the overlap between investors’ long-term financial interests and environmental or social objectives as seen from the public interest perspective.
Finally, we need to address the functioning and stability of the financial system as a whole. The overriding purpose of superannuation funds and other long-term savings institutions is to deliver financial security in retirement to millions of ordinary people. To do this, these investors depend on markets that are stable, well regulated, transparent and fair. As we have seen, poor governance of the market as a whole can be hugely damaging to long-term investors’ interests. At the policy level, a small number of the largest asset owners are already engaging actively with policy makers and regulators on the new market frameworks that are being put in place in response to the financial crisis. The more institutions become involved in work of this kind, the greater the chance that the re-modelled financial system will be fully aligned with their interests.
This agenda calls for a whole new level of vision and courage from the responsible investment community. We need to apply existing research insights and experience better, develop new tools, re-engage with the leadership levels within investment institutions, collaborate more effectively, and be bolder in allocating resources.
Fiona Reynolds is Managing Director of the Principles for Responsible Investment Initiative, based in London.