Amongst the global elites attending the World Economic Forum (WEF) at Davos, financial companies represent the biggest single industry attendance, which makes it clear that it’s all about the political power of money. Power, politics and finance in today’s economic systems go hand in hand. So, when the world’s largest asset manager sends an open letter to its clients and to CEO’s of companies they invest in, you’d better be listening to the message.
Enter Larry Fink, CEO of asset manager Blackrock, who used the WEF to point to a forthcoming fundamental shift in finance, and in his words proclaims, “I believe we are on the edge of a reshaping of finance.” What this means is that he sees a shift in power. Where power goes, the money will follow.
The bottom line is that this shift will be caused by a growing recognition that climate risk is investment risk, and importantly, because capital markets discount future risks, changes in capital allocations will occur faster than climate change itself.
Despite the naysayers, increasing scientific evidence points unavoidably to human influence on all of earth’s major system processes, whether geologic, atmospheric or hydrologic. The most profound, and most visible shift, to even the layperson, is of course in climate change. The point is, financial power is shifting in recognising this as factual.
How will the money follow this shift? What does it mean for capital reallocation? The real message is that increasingly, the business of denial is being choked out of the system. Denial not just of climate change, but more importantly, denial of the negative externalities of the growth model that shareholders have essentially underwritten over the past few decades. This was a model that put profit maximisation at the front and centre of corporate business objectives. Today’s climate change, among other societal imbalances, is the end result of that narrow focus on such short-term gains. This decades-long push for economic growth has been built on an increasingly energy-intensive approach, in which the predominant component of energy is derived from fossil fuels, with the resultant climate effects that are incontrovertibly visible.
Plainly put then, in future, with a different set of shareholders emerging (the so-called Millennials) and who will wield power in a fundamentally different manner to the past, there will be no place to hide. Fink himself writes that, “…in the future, greater transparency on questions of sustainability will be a persistently important component of every company’s ability to attract capital.” In other words, if you need capital in the future, the future shareholders and capital providers are going to ask very different questions than just about your financial metrics and how profitable you have been.
For capital allocators, like asset managers, this pushes one to ask what sustainable investing is and what it actually means?
Sustainable investing in a simple sense is a shift from the short-term profit maximising investment approach to a long-term oriented societal benefit approach. It recognises that your shareholders are not just those whose names are recorded on some digital register or who may bear paper shares in the company’s name. Instead, it is a profound shift in the recognition of stakeholders being every human, every country and every community.
If one peruses most large corporate annual reports, one finds a distinct focus on short-term shareholder value creation (as in to maximise the prospect of monetary dividends) as the overall objective. And, as we know, most senior executives are both incentivised and rewarded for such a focus.
The problem with this approach is that it perpetuates the current pattern of wealth distribution and entrenches the inequality of income distribution. Thomas Piketty, in his seminal work, Capitalism in the 21st Century, speaks of an increase in distributive conflict as a result of this inequality. Increasingly then, as articulated by an increasing number of stewards of capital, of which Blackrock is but one, it will no longer be possible to deny or ignore the enormous social exclusion and related risks generated by shareholder capitalism.
The shift in power that is alluded to in a move towards sustainable investing implies a profound shift in thinking throughout the investing and capital allocation value chain. No longer can a) the analyst focus only on financial metrics to value companies; b) the portfolio manager focus solely on maximising total short-term return; c) the asset consultant focus solely on awarding mandates to those who have maximised such returns; d) pension funds turn a blind eye to which companies they are invested in; and certainly, e) CEO’s focus on satisfying their direct shareholders by pointing to their rising share price.
Paying lip-service to sustainability will no longer be possible in the future. Pledging to integrate Environmental, Social and Governance (ESG) factors into decision-making processes is but the baby-steps in what should be a fundamental re-assessment of purpose. An acknowledgement of previous shortcomings should go hand in hand with a renewed and transparent commitment to embrace this new finance paradigm. That would be the beginning of sustainable investing.