A trillion dollar call for new investment approaches



One can take no satisfaction whatsoever from the current meltdown in the global capital markets. Nor can we derive much comfort from the fact that we Canadians have so far fared somewhat less poorly than our neighbours to the south and elsewhere.

However, if there is any kind of silver lining at all within that massive financial cumulonimbus cloud, it is the fact that the entire sorry episode should serve as a massive wake-up call for international investors. More precisely, it is also a trillion-dollar advertorial for the broader analytical power, different perspective and insights, and potential added value of 'sustainability-enhanced' investment analysis and strategies.  (For the uninitiated, we define 'sustainability-enhanced' simply as including an analysis of environmental, social, and governance (ESG) factors in one’s investment analysis of companies).

The sub-prime debacle and its collateral damage have cruelly exposed the profound limitations and inadequacies of traditional investment analysis and risk management. If anything had remained of the illusion of Bay Street omniscience before the current crisis, certainly none does now. The fact that it was sustainability analysts who were the very first to detect and draw clients’ attention to the tip of the sub-prime iceberg back in October 2006 only reinforces the credibility of the entire analytical paradigm, with its long-term time horizon and more holistic, 360 degree risk radar.

While it has temporarily been obscured and supplanted by the market meltdown, the world of global investment is now in the early stages of a tectonic transformation more profound than anything it has witnessed in literally decades.  The 'Sustainable Investment Revolution' is driving a worldwide industrial restructuring, radically changing the very basis of competitive advantage for companies, and therefore for their investors. Fortunately, literally trillions of dollars worth of institutional asset owners and investment managers are slowly awakening to both the risks and the opportunities posed by ESG.

The bad news for them - and for the rest of us - is that they are not doing so nearly rapidly enough. In Canada, we have much to learn from our peers in Europe and even from the United States in this regard.

This new investment paradigm is being driven by a myriad of powerful transformational factors, including:

  • Accelerating natural resource degradation, scarcity and constraints, driven to a significant extent by the explosive pace of industrial development, population growth, and urbanization, especially in emerging market economies;
  • Dramatically increased levels of public and consumer concern and expectations for companies’ ESG performance, turbocharged by unprecedented levels of information transparency with which to assess it;
  • Tightening national, regional, and global regulatory require­ments for stronger disclosure and company performance on 'non-traditional' business and investment risks, including ESG ones;
  • The expansion and intensification of both industrial competition and institutional investment into emerging markets, where ESG risks tend to be most acute;
  • The ongoing revolution in information and communications technologies (the Internet, YouTube, Facebook, webcasts, bloggers, et al.), which has enabled and accelerated the emergence of a stakeholder-driven competitive environment with unprecedented transparency and, therefore, business risk;
  • Growing pressures from international non-governmental organizations (NGOs), armed with new financial and technical resources, credibility, access to company information, and global communica­tions capabilities with which to disseminate their analysis and viewpoints;
  • A substantial reinterpretation and broadening of the purview of legitimate fidu­ciary responsibility to include companies’ performance on ESG matters; and
  • An institutional investor base which is increasingly sensitized to ESG issues, newly equipped with better information, and both willing and able to act on its concerns.
  • Taken together, these global megatrends promise to make sustainable investment a dominant investment paradigm for decades to come. Despite these global megatrends, however, mainstream investors in Canada have been slow to adapt, imprisoned by a whole series of entirely wrong-headed but widely shared misconceptions:

1) Addressing sustainability factors is irrelevant or even inju­rious to risk-adjusted financial returns.

2) It is very likely a breach of fiduciary duty to incorporate sus­tainability factors into investment strategy.

3) There is no academically credible evidence to support the sustainable investment thesis.

4) Sustainability and other 'extra-financial' analyses are inevitably less rigorous and more arbitrary than traditional investment analysis.

5) All SRI/sustainability research and investment approaches are essentially the same, and are unhelpful at best and financially harmful most of the time.

6) Unlike any other single set of investment factors, sustainability factors have to add value all of the time; otherwise they clearly must be intellectually bankrupt, worthless, or even harmful.

Each one of these investment myths has now been convincingly demolished, and yet still the misconceptions persist. This disjunction between current investment thinking and practice on the one hand and the imperatives of the 21st century investment landscape on the other simply cannot last.

The election of Barrack Obama presages a seismic shift in U.S. energy and environmental policy, moving sustainability issues into a position of much greater prominence. As Canadians, we will be profoundly affected by these changes; the sooner we prepare for them the better. Institutional investors, unite! You have nothing to lose but your intellectual chains - and sub-par financial performance.

Dr. Matthew Kiernan is Founder and Chief Executive of Innovest Strategic Value Advisors, Inc., the #1 ranked research and advisory firm in the world in the sustainable investment field. His new book, Investing in a Sustainable World, was published in the fall of 2008 by the American Management Association.

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