First published on Pro Bono News
Pursuing the meaningful but long-term work in the ESG field can be a difficult journey. It is undeniable that “ESG” is an amorphous concept that is dominating conversations in financial markets.
As a broad umbrella term “ESG” refers to the environmental, social and governance factors which contribute to a company’s sustainability profile and overall performance. However, ESG can be adopted in a multitude of ways. As applied to credit risk, ESG is narrowed to refer to those environmental, social and governance factors that are financially material to a company’s performance and risk profile. Some investors, however, see ESG as going beyond what is financially material to also look at a company’s environmental and social impacts.
The outset of the pandemic marks an inflection point for institutions that purport to invest for the long term. Globalisation and technological progress have produced both prosperity and inequality over many decades. Since the global financial crisis, a growing chorus of investors and policymakers has railed against short-termism and advocated taking a long view.
What 2020 and 2021 taught us is that it’s the slow-burning risks that can matter the most. Exogenous risk, like regulatory shifts or a rise in sea levels, can be a source of excess return for institutional investors as companies position themselves to innovate and adapt – or see their business models vanish. For a universal, long-term investor, however, all risk is endogenous. Consider corporate tax payments, which perennially garner headlines when companies fail to pay their “fair share” of taxes. While corporations can, at a firm level, reap rewards from tax arbitrage, the wholesale impact includes gaps in funding for needs such as infrastructure and health care, while raising the risk of regime change that can upend the competitive dynamics and profitability of entire sectors. Long-term investors cannot afford to collect the short-term gains at the expense of crumbling infrastructure. They own both outcomes.
In recent years, long-term institutional investors have started to manage these economy-wide risks through collaborative engagements that aim to shore up market standards in areas ranging from corporate governance to climate risk.
Some are ready to go further and position themselves differently from a market dominated by short-termism. This includes an investment policy shift that emphasises the long term by adopting benchmarks that explicitly incorporate views of the future. While market capitalisation-weighted benchmarks best reflect today’s market value and opportunity set, long-term investors currently lack a way to proactively assert their beliefs about how markets will look years from now as risks from climate change or social inequality are eventually priced by the market. While the differences may be subtle, entailing, for example, a slight tilt towards more resilient assets, a shift from “reflect” to “assert” may allow institutional investors to look beyond blind spots that can come with a focus on the short term.
It is inspiring to see that the major challenges (biodiversity loss, climate change, over-exploitation of resources, pollution, etc.) are now addressed at a global level and play an undisputed and important role in the political landscape. However, implementing these policies at the local level can be complex and time-consuming. The big picture needs to be better communicated to and with citizens everywhere, so that the challenges and changes ahead find wider societal acceptance under the shared idea that indeed we’re all in this for the long haul. The pandemic has shown that this could be possible.
The year ahead has the potential to test institutions and portfolio companies that espouse a long-term orientation. The temptation to time the market in response to (or in anticipation of) events – real or rumoured – could prove too powerful a distraction for many. But for investors committed to the long term, 2022 may be the year to differentiate themselves from the pack and orient towards future decades.