Innovation, adaptability key to corporate sustainability, ESG pioneer says

Friday 20th November 2015

Two important factors often ignored by investors when assessing companies are innovation capacity and adaptability and responsiveness despite the pace of technological change which makes them increasingly critical, says Matthew Kiernan, a global pioneer in responsible investing.

Kiernan is the founder of sustainability-driven asset management company Inflection Point Capital Management, which has been on a mission since 2009 to redirect investment flows towards a more environmentally and socially sustainable economy – effectively to “re-engineer the DNA of Wall St”.

He told BusinessDesk on the sidelines of the Responsible Investment Association of Australia conference in Sydney that corporate sustainability is about much more than the ESG (environmental, social, governance) factors.

While there was general agreement within the finance industry of the importance of companies having innovation capacity and being able to adapt to disruption in their industry, few fund managers analysed it formally, he said. “They could serve to pull ESG from the margin to the mainstream because these other two characteristics have more intuitive appeal to the mainstream analyst and investor,” he said.

Investor awareness of ESG issues was improving but too many fund trustees and investment managers still thought taking those factors into consideration would hurt returns and potentially breach their fiduciary duties, despite the body of evidence to the contrary, Kiernan said.

“Trustees and investment managers have been subjected to soft intellectual intimidation if they raise issues like climate change,” which had a chilling effect on changing investment behaviour, he said. Many investment managers still claim a lack of client demand for ESG investing. “There’s a fairly myopic view from leaders in the industry that confuse a lack of articulated demand with a latent demand they could galvanise”.

Kiernan thinks change will be slow until there is an inter-generational wealth transfer in the next 15 years to Millennials, who have a different values set to their parents and are “well-attuned to these issues”.

The Responsible Investment Association of Australasia released a report this week outlining nine industry priorities aimed at a shift towards focusing capital on delivering long-term value and financial markets towards a more sustainable footing. The initiatives include better corporate disclosure on how long-term value creation is delivered, including ESG factors, through tools such as integrated reporting.

It also argues for short-term quarterly earnings and earnings guidance to be abandoned because they distract corporate executives from investing in the long-term, and provide incentives to management to focus on short-term earnings and costs.

The frictions between long-term focused pension funds and short-term focused corporate management was raised by key note speaker Martin Skancke, board chairman of the United Nations-supported Principles for Responsible Investment, who helped devise the framework for the oil-fuelled Norwegian pension fund in the mid-1990s.

Auto giant Volkswagen’s emissions cheating scandal was an example of that mismatch, he said.

“Do we really think that the people cheating on these tests were acting in the best, long-term interests of shareholders? They did it because we, as shareholders, have set up systems to incentivise management to sell as many cars as possible,” he said.

The RIA claimed the move towards responsible investing was the “democratisation of capital” with consumers wanting more say in how their retirement savings are invested. But even proponents admit the financial industry’s prevalent attitude remains opposed to introducing an ethical overlay to investment.

Skancke said responsible investing was about 10 to 20 years behind health and safety reform which was initially rejected by corporates yet few global companies now say health and safety is not part of their DNA.

NZ Superannuation Fund chief executive Adrian Orr said his fund, which manages almost $30 billion in assets, believed ESG produced material long-term returns.

In a white paper released this week, the fund said when it first started building its responsible investment framework, evidence on responsible investing was thin on the ground and not particularly conclusive. Since then, more than 100 academic studies on ESG have been published that show overall strong evidence that companies that do well on ESG metrics tend to perform better. Specifically they have a lower cost of equity and cheaper borrowing costs, better corporate performance, and better market performance including higher share prices.

Orr said the fund had come under pressure from campaigners to divest holdings such as oil stocks and while it had excluded some holdings, its preference was to engage with companies to change their behaviour.

His advice to other funds and asset owners was to establish your values and then set out investment principles in a clear, transparent way or face “death by a thousand paper cuts and students chained to your front desk”.

BusinessDesk.co.nz

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