By Cheryl Smith, Managing Partner of Trillium Asset Management
Over the past 20 years, U.S. assets invested using a Sustainable and Responsible Investing (SRI) framework have increased five-fold, from $639 billion in 1995 to over $3 trillion in 2010 according to the Trends Report from the US SIF. Concomitantly, institutional investors worldwide now recognize the efficacy and legitimacy of the incorporation of environmental, social, and governance (ESG) factors in investment analysis.
The use of environmental and governance factors is widely accepted as a tool in investment analysis, and is spreading from its original home in long-only equity strategies of the activist and SRI community to additional investor groups, asset classes and strategies. The use of environmental and governance factors is becoming more widely accepted, even on Wall Street. Over the next 20 years, we must shift the focus of sustainable and responsible investing to the context within which companies operate: their competitive environment, their implicit or explicit license to operate, and the ways in which corporate actions, influence, and power change social and political systems.
Our goal as investors is to use the ownership of capital to create sustainable communities, and more broadly, a sustainable world. Sustainability is the capacity to endure, and hopefully to flourish, over time. In a human context, it is the potential for long-term maintenance of well-being; it therefore must take into account both short term and long term viability. Sustainable development meets the needs of the present without compromising the ability of future generations to meet their own needs, and balances current and future needs and growth.
Sustainability-motivated investors begin with the premise that traditional methods of investing neglect a critical aspect of the investment decision: investment creates ownership, and ownership of capital implicates the owner in all of the activities of the companies owned, including their product, their environmental impacts, governance, labor practices, and participation in the economic and social structures of the countries within which they operate. Initially, investors focused on a fine-grained analysis of companies: what does THIS particular company do, how do they do it, what effects do the company’s actions have, and do we as investors want to participate in those actions? Or can we, as active owners, induce a change in the company’s actions by engaging management and other shareholders? While this approach has led to significant changes in corporate behavior, it is limited to company-by-company actions, and reinforces the belief that the sole guideline/measure/responsibility of corporations is to the rate at which they return profit. It does not address the disconnect between the primary goal of corporations, which is growth, and the reality of finite limits imposed by nature. Without changing the competitive milieu within which corporations operate, we can’t create true change, because the competition between companies continues to reproduce the behavior. We must now move the locus of sustainable investing from the actions of individual corporations to the role of corporations in the broader global society and economy. To do so, we must broaden our tools to include analysis and advocacy for policies, laws, and regulations that create a competitive environment consistent with sustainability.
For true sustainability over time, a community must have economy, equity, and ecology all in balance. Economy balanced with equity, so that economic growth benefits all members of a community, but allows for enough difference in outcome to encourage effort and risk-taking.
Ecology balanced with equity, because widespread poverty leads to exploitation of natural resources and common areas, devastating ecological systems. Ecology balanced with economy, so that the wise current use of resources is counterpoised with the preservation of potential future growth. These three elements of a sustainable community play out over different time horizons.
Economic factors play out over very short periods, such as business cycles and financial crises, and also over long periods. Economic development and rapid growth can create wrenching social and environmental changes, such as the industrial revolution in England, rapid urbanization in developing countries such as Brazil, India, and China, and widespread clear-cutting of tropical forest land for cash crop cultivation. The limited liability, multi-owner, independent and separate legal entities known as corporations speed up the pace of commercial and economic growth, since they streamline the purpose of business: they abstract business from a concrete focus on WHAT is produced and move the focus to the overall rate of profit growth, simplifying corporations’ ability to change product lines and businesses. This simplification has jump-started the speed of economic growth – and exacerbated the issues of inequality, uneven growth, and ecological limits.
We can make this happen: change can be sharp and sudden. Significant social and economic change seems to happen in lurches, fits, and starts, through upheaval and cataclysm, and not in a smooth and continuous pattern. In just 12 years, the US moved from shock over the 1957 Sputnik launch to the 1969 Apollo 11 moon landing. Over the past 20 years, the development of widely-available internet access and the ensuing explosion of information and connectivity have transformed the social, commercial, and technological lives of people throughout the world. Established pathways for the dissemination of information have been upended. Recent events have demonstrated the power of instantaneous and open communication and its ability to topple political regimes. At the same time, the information and communication explosions have set the preconditions for sustainable investing. Information about what corporations do and how they do it has become much more widely available. At the same time, investors’ abilities to communicate this information have grown exponentially.
We’ve done a good job in getting corporations to grow. We’ve done an OK job in getting companies to recognize environmental issues, primarily by working together, by creating multi-stakeholder coalitions. Shareholder concern about environmental issues is now established as an appropriate area of inquiry. Management of climate risk is now a established best practice: with Board oversight, leadership by CEOs, compensation incentives for effective management, greenhouse gas emissions reporting and target setting, and the search for profit opportunities in a carbon-constrained world. At the same time, pressing environmental constraints are becoming more evident, including growing levels of greenhouse gasses, climate change, and re-emerging clean water scarcity. History shows us that when environmental constraints are binding, they can be extremely binding, in the form of famine, catastrophic crop failure, and disease, such as the Irish potato famine. Medieval historians have given us evidence of the role of overcrowding, poor nourishment, famine, and chronic malnutrition in the devastating impact of the Bubonic plague in 14th century Europe. Against such a history, the need for cooperation and responsive behavior is compelling.
The missing piece in sustainability discussions to date is the equity, or social dimension. Environmental issues, environmental degradation, and political instability are tied to poverty. Female literacy is tied to economic growth and economic progress. Ever-growing income and wealth inequality leads to economic stagnation. Inequality, and the ensuing widespread poverty, drives poor economic performance. We’ll make no progress on solving these issues unless we begin to recognize the interdependence of economic and social conditions, and stop treating them as separate issues. Human rights, political rights, and intra-country conflicts are inseparable from the economic welfare of the mass of the population.
The next 20 years will witness the increasing importance of the social component of environmental, social, and governance factors triad. Over the past 10 years, we have seen flashes – that could still be ignored – of the importance of poverty and income and wealth distribution in shaping geopolitical outcomes. The United Nation’s Millennium Development Goals, aimed at reducing world poverty, recognize the interdependence of environmental sustainability, transparent financial, trading, and business governance systems, and social outcomes such as gender equity, maternal and child health, and universal education, with a special emphasis on female literacy. The thriving global corporation of 2032 will recognize that its continued successful existence depends upon addressing critical supply chain issues, and that its ability to grow depends upon an expanding consumer market. The attractiveness to a corporation of shifting production to any location depends upon the education and basic health of a country’s workforce, the existence of a supporting infrastructure, access to clean water, and cooperation and partnership with national governments. Ever growing levels of income and wealth disparity limit the potential for sales growth and the expansion of markets. Further, continued economic prosperity, at the crudest of levels, depends upon political stability. The Arab Spring was initiated by the actions of a single Tunisian fruit seller, self-immolated in response to poverty, corruption, and harassment by local political authorities. In the US, the Occupy Wall Street movement expresses the frustration of a broad spectrum of society, the 99%, at income and wealth inequality. Investors ignore this information at their peril.
How do we as investors address the social and equity dimensions? We must adopt a broad systems perspective and consciously address the role of policy. How do the rules, regulations and policies in each separate national economy influence corporate behavior? What leverage, for good or for ill, do corporations that span national borders have over national economies and governments? How do we shape the rules and the context within which corporations operate? The next 20 years will not be about the HOW of what we do – what asset classes, what tools, what metrics – but about the WHY – how do we create a policy environment that creates a level playing field, that establishes the economic conditions for continued, but measured growth with widely dispersed benefit. How do we set a policy framework in which corporations are not determining political outcomes? While rampant pursuit of profits may be appealing in the short run, it is the ideology and logic of the cancer cell: growth at all costs, leading to the ultimate death of the host. Our challenge is to develop a framework of cooperation and regard for the general social welfare to counterbalance unlimited growth.
Article by Cheryl Smith is managing partner, chief compliance officer, and investment manager at Trillium Asset Management, LLC. Cheryl served on the Board of US SIF for six years; for three of those years she served as Chair. She is currently on the Board of Oikocredit USA, the US arm of Oikocredit, a worldwide organization empowering disadvantaged people with credit. She is a Chartered Financial Analyst charterholder and a member of the CFA Institute and a member of the American Economic Association. She holds a B.S.F.S. degree from Georgetown University School of Foreign Service, and a Ph.D. degree in Economics from Yale University.
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Trillium Asset Management, LLC is the oldest independent investment advisor devoted exclusively to sustainable and responsible investing. With over $1 billion in assets under management, Trillium has been managing equity and fixed income investments for high net worth individuals, foundations, endowments, religious institutions, and other nonprofits, since 1982. A leader in shareholder advocacy and public policy work, Trillium\’s goal is to deliver both impact and performance to its investors.
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