Sustainable Investing

Revolutions in theory and practice

Cary Krosinsky, Sophie Purdom, Cary Krosinsky, Sophie Purdom

• Publisher: Routledge
• Year: 2016
• eBook ISBN: 9781317192848
• Edition: 1
• Topic: Economics
• Subtopic: Sustainable Development
• Index: Economics

A seminal shift has taken place in the world of investing. A clear and overarching reality has emerged which must be solved: financial considerations must factor in sustainability considerations for ongoing societal success, while sustainability issues equally need to be driven by a business case. As a result, investment practices are evolving, especially towards more positive philosophies and frameworks.

Sustainable Investing brings the reader up to speed on trends playing out in each region and asset class, drawing on contributions from leading practitioners across the globe. Implications abound for financial professionals and other interested investors, as well as corporations seeking to understand future investment trends that will affect their shareholders' thinking. Policymakers and other stakeholders also need to be aware of what is happening in order to understand how they can be most effective at helping implement and enable the changes arguably now required for economic and financial success.

Sustainable Investing represents an essential overview of sustainable investment practices that will be a valuable resource for students and scholars of sustainable banking and finance, as well as professionals and policymakers with an interest in this fast-moving field.

Part I
How

Chapter 1
The seven tribes of sustainable investing

Cary Krosinsky

As we start to consider sustainable investing and what it needs to become, a first essential step is to establish and clarify the state of the field and all of its varying practices. Very specific strategies are often quite different and distinct within the field, and are all too often lumped into a single ‘I’m likely to give up returns' umbrella by those less familiar with it. Sustainable investing is very much not returns-jeopardizing, fortunately. Think about the difference between funds with a religious mandate and funds seeking to invest in water infrastructure for just one of many examples of how different strategies can be.

Also, as you will see in the next chapter, when you really dig in and compare and contrast strategies, investors can seek maximum financial performance without needing to sacrifice financial returns, and positioning portfolios towards the future may well also become a source of alpha.

Here for us is where the rubber hits the road, and the confusion which remains on terminology and performance needs to be better understood by anyone in an investment decision-making position of authority.

And so for the sake of this clarification, we introduce here the concept of:

The seven tribes of sustainable investing

Sustainable investing and impact investing are the two most frequently heralded terms referencing seven separate investment strategies which are in actuality very different in both practice and performance.

These ‘seven tribes’ include:

1. Values first – the roots of the field, practiced first as implementations of religious mandates, manifested as negative screens typically on sectors such as alcohol, tobacco, weapons, more recently South African apartheid, Sudan, and fossil fuel. This area remains two thirds of the $21 trillion of assets under management factoring in environment, social and governance (ESG) factors in some way as of 2014 (GSIA, 2015). It is often also called ethical investing (also the main manifestation of responsible investing as well as the now more antiquated term socially responsible investing). Islamic or sharia finance is often practiced as a form of negative screening, but in its pure form is a version of the shared economy, with shared ownership constructs at its heart. Values first investing is less interested in financial performance, and many studies show it often at best meets benchmark performance, leading to a broader perception of the entire field being philanthropic in nature, and as a result not fit from a fiduciary duty standpoint.
2. Value first – championed by the likes of Generation Investment Management and Parnassus Investments, both of whom have gained over $US10 billion in assets in recent years, value first investing using ESG as among primary considerations has gained in strength given its ability to encourage societal improvement while allowing for the potential for financial outperformance. Some call for value first investing to be called sustainable investing, which if scaled, could create the missing dynamic allowing for profit and societal benefit to be truly scalable simultaneously. Generation has beaten its benchmarks over its first 10 years while most active fund managers underperformed, yet has capped its fund, so scalability can be a challenge. Parnassus grew over the past eight years from under $1 billion to $15 billion in assets under management.
3. Community/impact – community investing has a long-established history of investing with intention to improve the wellbeing of a specific region and group of targeted individuals. So-called ‘bottom of the pyramid’ focuses and implementations of microfinance are also in this sphere, as is much of the history of social business. More recently, impact investing has risen as a lens for investors seeking to have positive societal and environmental effect with their investments through intentionality. For example, a First Nation in Canada financing a wind farm would create a local, environmental and community benefit. Most impact investments have been implemented within the realms of access to medicine, housing, education and healthcare for the world's poorest, though some use an overarching definition of impact investing to include all of the possible strategies listed here. Chapter 3 provides further detail.
4. Thematic investing – typically private equity or venture capital in nature, but also available through some mutual funds (including the largest ESG fund in Europe, Pictet Water Fund), thematic investments are often focused on areas such as cleantech/renewable energy or water among other related innovations and categories of environmental finance (such as conservation). This would be the extreme case of sustainable investing on the one hand seeking positive intentionality, with the other extreme being a negatively screened public company fund based on a large cap global liquid index. Climate/green bonds are a growing area of interest within the space of thematic investing, as is the nascent area of green infrastructure, and arguably green real estate can also fit here. Chapter 11 and Chapters 11a–11g go into further detail on how investors focus thematically.
5. ESG integration – generally carried out by analysts, asset managers and investors, bringing in ESG data from one or more external providers and using that as one more set of criteria to analyze the strength of a business among a variety of more traditional factors, is also on the rise. Some, for example, have been known to use bottom performance on ESG as scope for further research when potentially committing to lending as part of due diligence. Asset owners also use bottom performers to decide on engagement activities (active ownership is the process of exercising your rights as a shareholder to influence management and performance). ESG integration needs to combine data access with specific strategies to be effective.¹ We provide examples of a few investors in the chapters that follow, and our previous book Evolutions in Sustainable Investing also detailed methodologies used in practice.
6. Engagement/advocacy – the field of shareholder engagement is practiced both openly through shareholder resolution and public discourse on issues such as stranded asset risk, as well as on compensation, tax and many other issues. It is also often practiced quietly, with agreements not to go public after extensive dialogue. Record levels of participation are being seen in climate change shareholder resolutions alongside all-time-high quantities of resolutions being filed. Arguably the most successful strategy deployed to date by investors attempting to facilitate positive change (see Chapter 7 on the PRI Climate Change Asset Owner Framework and related case studies and Chapter 15 on the various strands of activity surrounding positively focused shareholder activism). This also includes engaging with policymakers, and asset owners with their outsourced fund managers where such are used.
7. Norms-based screening – mainly a Northern European strategy, typically involves using United Nations (UN) principles, including the UN Global Compact and the UN Guiding Principles on Business and Human Rights, as a minimum standard for investment.

Combinations of the above seven strands of activity are often deployed by investors when seeking to address specific issues; for example, the Principles for Responsible Investment (PRI) in 2015 created a Framework for Asset Owner Climate Change Strategy combining additional specific allocations of capital with engagement in three ways – with corporates, on policy and with outsourced fund managers, as well as selling companies for which there is no perceived business case.

Social issues can be resolved best through intentional investing and multi-stakeholder dialogue. Governance is often addressed through attempting to improve bottom performers as identified through ESG data and analysis.

Financial performance also widely differs, based on which of these strands are deployed. We understand those who assume they will leave returns on the table when deploying negative screening, and the academic literature is filled with cases where such strategies were suboptimal.

Separately, positive sustainable investing has been a major source of financial performance as well, as we will see in the next chapter detailing the work of our class at Brown University, and as we discussed at length in our first two books on this subject.

Note

1 For example, see Chapter 34 of Evolutions in Sustainable Investing (ed. Cary Krosinsky, Nick Robins and Stephen Viederman, New York: Wiley, 2011) on Insight Investment Management and their designed ESG strategy process.

Reference

GSIA (Global Sustainable Investment Alliance) 2015. ‘Global Sustainable Investment Review 2014’. www.gsi-alliance.org/members-resources/global-sustainable-investment-review-2014/ (accessed 8 September 2016).

Chapter 2
From far-fetched theory to best practice

Sustainable investing at Brown University

Sophie Purdom

It started metaphorically: caught in tangled electrical appliance cords in the dark under my high school teacher's desk.

I emerged with data in hand and an epiphany brewing in my mind. By unplugging unused appliances, my school could save electricity being drawn as phantom load for very little effort and a high impact. We got to work on a sustainability program that through carefully communicated behavioral change succeeded in reducing our high school's electricity consumption enough to hire two new teachers.

At the core of the program is the theory of the sustainability/financial value nexus – that same epiphany that I had unplugging cords in the dark, that saving energy is great for the world and all of us in the long run but saving money is great for the individual right now. If we are to achieve the necessary and immediate transition to a low-carbon economy that will save our planet from catastrophic anthropogenic warming, sustainability must learn the logic and language of finance because, for good or for bad, economics is the universal language of the present and we need universal action now.

Brown University complicated that. I arrived on campus to a sea of passionate and critical students rising up to challenge the Brown Administration to be a leader around fossil fuel divestment. Through clever public actions, rallies, high-profile lectures, and mass petitions with over 2,000 signatories Brown Divest Coal demanded that Brown ‘divest from the 15 filthiest coal companies’. Their actions brought to campus mountain top removal activists, bioethics professor Peter Singer, the CEO of Duke Energy, and Bill McKibben of 350.org. Students, faculty, staff, alumni, and the Brown community at large coalesced behind the demand to divest from coal for ethical reasons including human rights, intergenerational equity, and environmental justice. On February 6, 2013, the Advisory Committee on Corporate Responsibility in Investment Policies (ACCRIP) recommended that the university assume Brown Divest Coal's demands ‘given the well­ documented human and environmental impacts of the coal industry’.

On October 27, 2013 President Christina Paxson released a letter¹ to the Brown Community announcing the Brown Corporation's decision to not divest from coal. Her letter tipped a hat to Brown Divest Coal for revealing the social and environmental harm caused by coal but continued, ‘The existence of social harm is a necessary but not sufficient rationale for Brown to divest’ and ‘by the fact that coal is currently necessary for the functioning of the global economy’ a judgment call that divestment would improve such social ills would be ‘a difficult one at that’. She then suggested:

The second question to consider is whether divestiture would help correct the social harm by speeding the transition away from coal. It is clear that divestiture would not have a direct effect on the companies in question. Brown's holdings are much too small for divestiture to reduce corporate profits. Furthermore, because the profits of these companies are determined primarily by the demand for their products rather than their stock prices, divestiture would not reduce profits even if Brown's holdings were orders of magnitude larger.

In sum, the financial impact of divestment on coal companies had been lost in the emphasis on social harm. The sustainability/financial value nexus had not been proven.

With the precedent of Divest Coal in mind, I set out in search of the sustainability/financial value nexus. As a part of many teams we wrote the Sustainable Providence plan, passed the Resilient Rhode Island climate change Act, and held fossil fuel executives on message at the UN Framework Conventions on Climate Change. I interned in Boston with Ceres, seeking to prove that the Carbon Asset Risk from high-carbon, high-capital expenditures made by certain public fossil fuel companies was worth engaging company management about. The idea stuck and now Ceres, the Carbon Tracker Initiative, and students from Yale University are leading the conversation with investor networks engaging with carbon majors on climate risks.

This idea that analytical incorporation of material information on environmental, social, and governance (ESG) could drive superior financial performance while doing good for the planet and people drew me to the Brown Socially Responsible Investment Fund (SRIF). A student group managing $50,000 of the university's current use funds, SRIF put this ESG theory to practice in managing a concentrated portfolio of public equities. In order to be added to the SRIF portfolio each stock must meet financial and ESG performance standards. Each week the SRIF team met to deliver a presentation on a target with the intention of garnering enough votes from peers in the audience for the stock to pass on both finance and ESG. Over the course of my time with SRIF our standards for what made a successful ESG company developed as we integrated materiality assessments from leaders like SASB, a breadth of scientific, market, and social understanding from our diverse team, and data from MSCI ESG Analytics. Our investment approach began to shift too. Rather than metrics we focused on materiality. Rather than short-term fads, we followed long-horizon trends. We practiced what we preached about corporate governance and invested in our expanding membership through trainings, career networking, and mentoring. We expanded our leadership suite from a small homogeneous group to a 15-person board inclusive of all years, majors, and personal backgrounds.

It paid off. The Brown Administration decided that our performance proved that ESG investing warranted equal support to that of traditional investing and increased our assets under management to over $120,000 to match the seed funding of the Brown Investment Group. With a 13.5 percent return in 2014 and performance beating the S&P 500 each year since, SRIF has consistently outperformed 80–90 percent of money managers through a difficult period.

For all of SRIF's successes, one of its greatest achievements was the opportunity it afforded students to begin a dialogue with the Brown Investment Office. Due to the work of Brown Divest Coal, the Investment Office's attention had pivoted towards socially responsible investing. With the encouragement of President Paxson, the Investment Office began to take action to achieve the goal of significantly incorporating ESG considerations across the endowment. I was brought on as an intern to share SRIF's experience. The divestment discussion had highlighted an immediate and pressing demand for a fossil fuel free endowed option. As an immediate win that would go beyond such a demand and establish Brown as a leader in the space, we began to develop the nation's first institutional endowed sustainable investment donor option. The Brown University Sustainable Investment Fund will seek to drive long-term capital appreciation for the Brown Endowment by making investments well-positioned to mitigate the system...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of illustrations
• Notes on contributors
• Acknowledgments
• Introduction: the future of investing is sustainable
• PART I How
• PART II Systems and systemic solutions
• PART III The next frontier
• Conclusion: climate and impact
• Appendices
• Index