Sustainable Investing & Stakeholder Capitalism
(Originally published December 2019)
There’s a lot of hand-wringing in the investment world today about the meaning of sustainable investing. Most asset managers have some sort of ESG initiative underway but they struggle to define it and why they’re doing it. Advisors want to offer it to clients but are often unsure how to talk about it. End investors overwhelmingly say they’re interested but look to these same advisors and asset managers for guidance on turning their interest into actual investments. What in the world is happening here?
We’re in the midst of a paradigm shift, and as happens during such shifts when they take place in any field, the practitioners of the old way of doing things – in this case, a focus on short-term returns and traditional concepts of risk – are being left mostly flat-footed.
The old investing paradigm aligns with the notion of shareholder primacy, the idea that the purpose of a public company is to maximize shareholder value. That notion is also on the wane, and for good reason.
Combined with deregulation and tax cuts skewed to the wealthy and corporations, shareholder primacy produced enormous wealth for investors from the late 20th Century through the financial crisis and during its aftermath. Corporate profits set records, which was good for shareholders and corporate managers, but wages for workers stagnated, inequality increased, and tax cuts for the wealthy failed to produce economic outcomes that “trickled down” to the benefit of all. Meanwhile, lost revenue limited government’s ability to finance investments in the social safety net, public education, research, and infrastructure. The planet suffered too, as companies were able to off-load their negative impacts (“externalities”) on the environment and climate.
The failure of shareholder primacy is reflected in the growing sense that global capitalism just isn’t working for most people. And over the long run, that means it won’t work for shareholders, either.
Sustainable investors have long argued for a different model, one that has gained significant momentum in the past couple of years. Rather than focusing on maximizing short-term returns for shareholders, a public company should focus on serving all its stakeholders well, its shareholders, but also its customers, suppliers, workers, the communities it impacts, and the environment.
Indeed, companies today face heightened expectations to be good stewards of the environment, to treat their workers well and pay them fairly, to encourage diversity, respect human rights, deliver safe and useful products, protect their customers’ privacy, and govern themselves in an ethical and transparent manner. This requires making decisions through a sustainability lens, which considers the impact of decisions on all relevant stakeholders today and over the long term.
The shift in thinking about the purpose of the corporation is illustrated by the Business Roundtable’s new statement on the purpose of the corporation. Released in August, to much fanfare, the business trade organization explicitly renounced the notion of shareholder primacy, which it had endorsed for more than 20 years. In its place, the group said corporations have a fundamental commitment to all stakeholders and to generating long-term value for shareholders.
While sustainable investment strategies vary in their particular investment approaches, at some level most of them are trying to identify companies that are pursuing stakeholder value, avoid those that aren’t, and engage with the ones they own as shareholders to urge them in that direction. In so doing they are not only aligned with the new stakeholder-value paradigm, they are helping bring it into being.
Over the long run, corporations are more likely to adopt this worldview if they know they have a base of support for it among their investors who believe that long-term sustainable value for shareholders and society results from corporations being managed from a stakeholder perspective.
In one recent survey, an astounding 85 percent of investors said they’re interested in sustainable investing; in another, 82 percent agreed that when people work together, they can be effective at changing companies’ behavior.
Thus, my message to those struggling to define sustainable investing: don’t over-complicate it. Sustainable investing is still investing that aims to deliver competitive risk-adjusted returns, but it also raises the bar on traditional investing by supporting the transition to the new paradigm of stakeholder capitalism. In so doing, sustainable investing is helping make capitalism work better for everyone.
Article by Jon Hale, Ph.D., CFA, head of sustainable investing research for Morningstar. He directs the company’s research initiatives on sustainable investing, beginning with the launch of the Morningstar Sustainability Rating™ for funds in 2016.
In 2018, Hale was named to Barron’s list of the 20 most influential people in ESG investing, and in 2019, he was included in the InvestmentNews’ 10 leaders of ESG & Impact investing.
Before assuming this role in 2016, Hale was director of manager research, North America, for Morningstar, where he led approximately 60 manager research analysts based in North America and oversaw the team’s operations, thought leadership, and manager research coverage across asset classes. Hale first joined Morningstar in 1995 as a mutual fund analyst and helped launch the institutional investment consulting business for Morningstar in 1998. He left the company in 1999 to work for Domini Social Investments, LLC before rejoining Morningstar as a senior investment consultant in 2001. He became managing consultant in 2009 and head of the Investment Advisory unit in 2014.
Hale holds a bachelor’s degree, with honors, from the University of Oklahoma and a doctorate in political science from Indiana University.