We need to talk about value
Responsible investor beliefs and practices which demand that the great sustainability challenges of our time fit within existing investment theory is bankrupt. It is the theory that must evolve to support what economist Kate Raworth calls a safe and just operating space for humanity. If the industry is unable to broaden its approach so that investment theory and practice fit within environmental and social guardrails, it will fail to capture the real-world value which must be its goal (and the key to its survival).
At the RIAA conference, Altiorem arranged a presentation titled Need a New Anchor, which explored whether assessing value through a two-dimensional view of risk and return is holding responsible investors back from supporting the economic transition needed to achieve a safe and just operating space for humanity. We argued that investors must shift their anchor so that “risk adjusted returns” is no longer its own end, with investors instead managing risk and return in pursuit of positive real-world impact.
We were fortunate to have Altiorem’s founder, Pablo Berrutti, joined by behavioural scientists Abby Wild from Monash University’s BehaviourWorks and Saul Wodak from the Behaviour Insights Team, along with experienced responsible investor Désirée Lucchese.
Institutional investors must prudently manage their investments and act in the interests of their clients. That is their job. However, the decisions investors make can contribute to a world which is either 1.5oC warmer, difficult but manageable, or one that is degrees hotter, where society and therefore the ability to manage investments breaks down. Biodiversity, pollution, inequality, racial and gender injustice can all be influenced positively or negatively by investors. All have value for clients and society at large which extend far beyond what can be expressed in a calculation of risk and return.
There is a problem for responsible investors who believe existential risks and financial objectives are aligned, and therefore these issues can be adequately addressed by integrating them into existing investment practice. It is true that financial objectives are more achievable in a safe and just operating space for humanity than one where climate driven chaos, mass extinction and extreme inequality result in societal breakdown.
However, it does not follow that attempting to convert sustainability guardrails into financial expressions of risk and return will make the better of these possible futures more likely. Indeed, we showed through multiple examples that by treating these guardrails as fungible with financial gains, they are often traded-off or not prioritised at all.
One example of investors not prioritising existential threats was a survey of 60 Australian institutional investors conducted by the Behavioural Insights Team for MarketMeter. It found that out of 26 corporate priorities, climate risk ranked close to the bottom (see chart).
While all issues were considered important, and indeed they all are important, the low relative rank of climate change, social license and management of supply chains reflect a prioritisation of factors which relate to the mechanics of running the organisation over the outcomes and impact the organisation has in the world. The Behavioural Insights Team wrote a separate blog on their findings which can be found here.
We will not solve the climate and the other existential crises we face if it is the 22nd thing we look at.
If the foundations necessary to achieve a safe and just operating space for humanity cannot and should not be treated only as financial risk and return considerations, then they must have their own place from which they cannot be traded off. Rather than only being factors that make assets or portfolios more or less risky, they must be the guiding light towards which investors’ consideration of risk and return are directed.
Without anchoring investment objectives in this way, the pursuit of risk adjusted returns can undermine both the ability of investors to contribute appropriately to sustainability objectives, and the risk adjusted returns they seek.
The presentation included two examples where interventions to achieve behavioural changes have been successful in other areas. The first, on patient centric healthcare showed how bringing a patient’s values and perspectives into treatment plans improved not just the patient experience but also health and cost outcomes. This was despite patients not having or adding additional medical expertise to that of health professionals.
The lessons for investors are obvious when surveys of retail investors show that they expect their existing financial institutions to invest responsibly and ethically. When listening the investment community has also achieved better outcomes. We have seen over many years the ability of ethical and sustainable investment options to perform as well as or better than their “mainstream” peers while prioritising sustainability and ethical issues. The body of evidence includes comprehensive meta-analysis by DWS Group and Hamburg University and even research from titans of mainstream finance like Morgan Stanley.
The second case study explored the success of reducing road deaths in Australia. Recognising the myriad factors at play, success was driven by interventions on both structural and system issues as well as behaviour change by individuals.
A strategy which is described as both changing the direction of the stream and teaching people how to swim.
For investors, the long-term focus on structural and policy changes in areas from disclosure requirements to the interpretation of fiduciary duty have yielded important successes, however, these interventions have largely been directed at fitting sustainability considerations within existing investment thinking and practice.
Our efforts have sought to bend existential threats into forms that can legitimately be included by investors rather than questioning the legitimacy of investment practices that deliberately exclude them.
In addition, even for this narrow approach to responsible investment, the industry has failed to teach people how to ‘swim’. This is evidenced by CFA Institute research the Future of Sustainability in Investment Management — From Ideas to Reality, which found only 11% of CFA charter holders surveyed felt they were proficient at incorporating sustainability issues, with only 50% working at organisations that offer any training on them, and with more than 70% wanting training in the next 12 months.
Altiorem was established for this purpose. A community-built, freely available library which supports its members to be more effective sustainable finance advocates and to implement the changes needed to make it reality. However, the behavioural issues we have discussed show that as important as good quality and accessible information is, it will only take us so far.
To be truly effective we can no longer accept that our responsibilities end after we have integrated existential threats into the same investment models that allowed their escalation. However, while this model may no longer be fit for purpose, an evolution is possible.
A new anchor for the industry means accepting that an optimal investment strategy should achieve its financial objectives while supporting and enabling a flourishing, equitable and healthy environment, society, and economy.
Failing in the second part of this goal must be seen as a failure overall. It means leaving the anchor of risk and return behind and setting a new one which manages risk and return in the pursuit of positive real-world impact.