Businesses live within the societies they serve. So, they cannot be seen in isolation of the general public good. Least of all, the business that aim to provide sustainable shareholder value. In a world where the Wall Street has an ADD where its collective mind cannot think beyond a quarter.. there are very few sane people who can have the guts to talk of that rare temporal species in Investing called – LONG TERM!
Surprisingly for me.. or not so.. one of such people is Al Gore. He had started this company to look at Sustainable Investing. David Blood, former head of Goldman Sachs Asset Management is the Managing Partner. It is called Generation Investment Management. They invest in sustainability. Here is an excerpt from an interview with them from McKinsey Quarterly.
The Quarterly: What did the history of sustainability investing teach you?
David Blood: Sustainability investing has a long history, starting back with the first wave of negative-screening strategies, where investors excluded entire sectors based on a set of ethical criteria. This strategy remained niche; returns were lackluster due to the fact that your investment-opportunity set was limited. The next wave of sustainability investing was called the positive-screening, or best-in-class, approach. That’s the philosophy of the Dow Jones Sustainability Indexes and the KLD Broad Market Social Index—these indexes replicate the underlying benchmarks but select only the best performers on environmental, social, and governance parameters.
However, the problem with this approach is that it’s difficult to get a real sense of what’s happening in those businesses, because it’s basically a one-size-fits-all approach, often using questionnaires for decision making. In addition, often one team does the sustainability research and then hands it over to the investment team to do the financial research. That approach, we believe, has too much friction in it because it misses the explicit acknowledgment that sustainability issues are integral to business strategy. So in setting up Generation, we saw the need to fully understand sustainability issues alongside the fundamental financial analysis of a company.
Al Gore: We don’t think it’s acceptable to force a choice between investing according to our values or according to the ways most likely to get us the best return on investment. Our objective in innovating with this new model was to focus on the best return for our clients, full stop. But we wanted to do so in a way that fully integrates sustainability into the model.
The Quarterly: That suggests greater complexity.
David Blood: Yes, sustainability research is complicated because it requires you to think long term and to think about the first- and second-order effects of an issue. We like to describe our approach to sustainability research as taking a systems view. What that means is, if you’re thinking about climate change you first need to understand the physical, regulatory, and behavioral impacts on business. But you also need to understand what a changing climate means for disease migration and public health, what it means for poor populations in developing countries, what it means for water scarcity or demographic and urbanization trends. The most important and challenging research is trying to determine how all these factors interact. Without that understanding, you can miss a significant part of the business implications.
The Quarterly: What principles drive your approach?
David Blood: The first principle, categorically, is that it is best practice to take a long-term approach to investing. We think that the focus on “short termism” in the marketplace is detrimental to economies, detrimental to value creation, detrimental to capital markets, and a bad investment strategy. It’s common corporate-finance knowledge that something on the order of 60 to 80 percent of the value of a business lies in its long-term cash flows. And if you’re investing with a short-term horizon you’re giving up the value creation of a business.
The second principle is that the context of business is clearly changing. We are now confronting the limits of our ecological system, and at the same time societal expectations of business are widening. On top of that, multinational businesses are oftentimes better positioned than governments to deal with some of the most complicated global challenges, such as climate change, HIV/AIDS, water scarcity, and poverty. Technology and communications have changed, and we’ve reached a point where civil society is now demanding a response from business.
The Quarterly: What’s your perspective on how that changes corporate strategy?
David Blood: In effect what’s happening, unbeknownst to many corporate leaders, is that the goalposts for their businesses’ license to operate have moved. There are higher expectations and more serious consequences, and the implications go way beyond protecting your reputation or managing costs. Rather, we see this changing context for business as an opportunity for companies to establish competitive positioning, grow revenues, and drive profitability. In the end, that’s the holy grail of sustainability investing—to seize the opportunities, not just avoid the risks.
The Quarterly: What has been the reception from pension funds and longer-term investors to this notion?
David Blood: Very good. They recognize that they have long-term liabilities, and it is their fiduciary duty to match those liabilities with assets. The recent adoption of the UN’s Principles for Responsible Investment by asset owners and managers representing over $8 trillion is a good example of the institutional-investment community beginning to commit to a long-term time horizon and the explicit recognition that environmental, social, and governance factors drive value creation.
From Generation’s perspective, we’re pleased with this awakening. If you go back to when we founded this firm, we thought that sustainability investing would eventually be mainstream, but we never would have guessed that the reception and focus on sustainability would be as loud and as urgent as it is today versus three years ago.
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