The short-term financial orientation of the investment community is one of the greatest barriers we face to creating a sustainable society.
The corporate community has made significant progress since 2000 in planning for the long term. Focus on environmental and social issues and corporate governance should give investors confidence and contribute to “external” benefits -- a stable society -- in the long run.
A common complaint among CEOs is that their shareholders, particularly the largest institutional investors, are indifferent to the banner issues of sustainability -- resource scarcity, human capital development and risk management, to name three. These issues rarely come up in quarterly analyst calls, and investors continue to focus on short-term financial performance. Without the support of their investors, who have the opportunity to earn substantial returns by thinking long-term, companies can only do so much.
In a previous article we noted the tremendous concentration of economic power in the world’s largest 1000 companies. In 2010 their aggregate revenues were $32 trillion. Their aggregate market cap of $28 trillion made up 49 percent of global market cap. Within this elite group a high level of concentration exists. Just 83 companies account for one-third of the group’s revenues; the top 172 accounts account for one half. Resource allocation decisions by the Global 1000, especially the largest ones, can have tremendous positive and negative impact on how millions of people live today, and how many more will live in the future.
Wealth concentration is even greater on the investor side, which unfortunately lags behind corporations in building long-term considerations into core strategy. The world’s largest 500 asset managers hold around $42 trillion in assets. The top 10 percent have 37 percent of this total, and the top 50 control 75 percent. According to the United Nations Report on Progress 2011, one-quarter of asset owners who are signatories to the Principles of Responsible Investment actively monitor how much attention their investment managers pay to environmental, social and corporate governance issues (abbreviated to ESG by professionals). Perhaps this is not surprising. Asset owners operate under the fiduciary obligation to deliver maximum returns to their beneficiaries. However, they tend to do so based on the false assumption that weighing ESG performance will hurt the overall performance of portfolios.
Other significant institutional barriers prevent asset managers from rigorously integrating ESG analysis into their decisions. Mandates from asset owners typically run only three years. Annual performance-based compensation is benchmarked by a set of peers and enforces short-term thinking. The failure of asset owners to include ESG scoring in their investment selection procedures and mandates virtually guarantees that there won’t be any. Short-term pressures on the asset owners themselves come from government regulators. The lack of rigorous measurement and reporting standards on ESG performance is a difficult challenge but is now being addressed by the new Sustainability Accounting Standards Board (Eccles is the chairman of SASB and Serafeim is on its Standards Council).
Corporate pension funds are not subject to most of these barriers to long-term investment -- unless they create them for themselves. The sad fact is that they do. Corporate pension funds are no better than others in sustainable investment.
This leaves companies that are embedding sustainability into their organization and supply chain in a curious situation. Even as they are working hard to formulate and execute a long-term strategy, companies’ own pension funds are often putting pressure on other companies to deliver short-term results. It’s worthy noting that sustainability success stories in the corporate sector are achieved despite these headwinds.
Corporate pension funds are a significant asset class, representing around $7.3 trillion in defined benefit and defined contribution plans. If corporations were to give pension managers explicit instructions to evaluate ESG performance with traditional scoring, they would doubtless screen out companies whose short-term performance is coming at the risk of longer-term stability. ESG investment analysis would also identify companies that are likelier to outperform over time. As these asset managers begin to see the positive financial returns they can generate from incorporating ESG into their fundamental analysis, they will adopt this approach for the assets they are managing for others. That will help make the investment management industry part of the solution rather than part of the problem. It’s happening already, but not quickly enough.
Corporate pension funds see great concentration, too. Just four funds account for one-third of these assets, eight account for half and 26 account for three-quarters. A simple exercise could have a very positive impact: The very largest corporations should instruct the very largest asset managers to perform ESG analysis -- just as many companies themselves now do. Logic suggests that the largest 100 companies in the world own a vast percentage of corporate pension assets. Thus a small number of companies directing an even smaller number of asset managers should make a real and positive difference.
Most surprising is the $43 billion in pension assets held by the United Nations Investment Management Division, 96% of which is managed in-house. While the United Nations and its Secretary General are involved in a plethora of worthy initiatives to create a more sustainable society, according to SAM, its pension fund appears uninterested in sophisticated ESG integration strategies when it makes decisions. Until all organizations—corporations, governments, and multilateral organizations like the UN—manage their pension assets in a way consistent with their rhetoric, the sustainability movement will lag behind its potential.
Baldinger is chief executive officer of SAM. Eccles is professor of management practice at Harvard Business School. Serafeim is assistant professor of business administration at Harvard Business School.
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