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A tipping point for sustainable investing

Jon Hale, Ph.D., CFA  |  12 Feb 2020Text size  Decrease  Increase  |  
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How did we get here? Gradually, then suddenly.

When a character in Ernest Hemingway's The Sun Also Rises is asked how he went bankrupt, he replies, "Gradually … then suddenly."

Being from Oak Park, Illinois, Hemingway's birthplace and childhood home, my ears perked up when I heard a colleague use the quote in a recent talk referring to the rise of sustainable investing.

How did sustainable investing get to be such a big deal? Well, gradually, at first, and then all of the sudden.

One need look no further than the nearly fourfold increase in assets that flowed into sustainable funds in the US last year. Such funds attracted more assets in just the fourth quarter of 2019 than in all of 2018, when the previous calendar-year record for flows was set.

sustainable funds estimated quarterly inflows 

Then to start off 2020, BlackRock (NYS: BLK), the world's largest asset manager, announced that sustainability would be its "new standard" for investing and told corporate CEOs that "climate change has become a defining factor" in their companies' long-term prospects.

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How did this happen?

Gradually, at first.

There are those who have preferred to invest in a sustainable and responsible way for many years, just not that many. But we've seen that investor base grow over the past decade or so, spurred by younger investors and women.

There has also been the gradual development of environmental, social, and governance data and its integration into investment analysis. ESG analytics are more robust and sophisticated today than ever before.

And most significantly, we've seen two overarching issues gradually come to the fore. The first is climate change and the second is the growing critique of the shareholder-primacy view of the corporation.

Now, rather suddenly, we seem to have reached a tipping point. People the world over are coming to the realisation that climate change is not a theoretical problem that may cause harm at some point in the distant future; it's a crisis bearing down on us right now.

The relentless march of extreme and uncommon weather events is being directly experienced by more and more of us. This year has started off with an entire continent on fire. Meanwhile, scientific consensus continues to build about the causes of and pathways to fighting the crisis.

So, investors are suddenly realising that, at a minimum, they need to better understand how climate change is affecting their investments at the asset-class, regional, industry, and company levels.

Going beyond that view are those who want to do their part to fight the climate crisis by intentionally investing in ways that will contribute to the transition to a low-carbon economy.

Turning to the role of the corporation in society, there has been a gradual realisation, going back to the financial crisis, that a singular focus on shareholders, especially on maximising quarterly earnings, may have created a lot of value for them, as intended, but perhaps not for the other stakeholders of a corporation – its customers, employees, the communities in which it operates, and the planet itself.

Now all of the sudden, we have groups like the Business Roundtable supporting a shift to a stakeholder-value model in which corporations view their raison d'etre to be serving and creating value for all their stakeholders, including the broader financial, economic, social, and political systems in which they operate.

In just the past week, three prominent US companies in addition to BlackRock have made major commitments to sustainability and stakeholder value.

Microsoft (NAS: MSFTannounced it would become 100 per cent carbon-negative by 2030, remove its historical carbon emissions by 2050, and launch a US$1 billion climate innovation fund.

Starbucks' (NAS: SBUX) "new sustainability commitment" is to become resource positive in terms of carbon emissions, eliminating waste, and water usage. "By embracing a longer-term economic, equitable, and planetary value proposition for our company," writes chief executive Kevin Johnson, "we will create greater value for all stakeholders."

Airbnb laid out its approach to focusing on stakeholder value, saying that "serving all stakeholders is the best way to build a highly valuable business, and it's the right thing to do for society." The firm, which is not yet publicly traded and has been dealing with quality and reliability issues, has set value-creation goals for all its stakeholders and metrics to gauge success, has created a board stakeholder committee, and has tied compensation to overall stakeholder success.

Not every company has shifted gears on sustainability and stakeholder value. Case in point: Boeing (NYS: BA) and the tragic case of the 737 Max. Boeing is a company mired in the old paradigm of shareholder primacy, cutting costs to bolster profits, which led to operational issues with the 737 Max and disastrous results.

A November article in The Atlantic details how Boeing changed its culture over the past two decades, away from its roots as an engineering firm to one focused on profits. Boeing "sacrificed quality on the altar of shareholder value," business journalist Joe Nocera argued in a column last week.

According to corporate-governance expert Nell Minow, this happened under the guidance of a "quintessential 1990s board," one that's narrowly focused on shareholder value and that's overpaid, overburdened with multiple board appointments, and lacking relevant engineering and aeronautical safety expertise – not to mention lacking a perspective on stakeholder value and sustainability that the company urgently needs going forward.

Clearly, not all investors nor all companies have embraced sustainability and stakeholder value, but the direction of travel now seems suddenly clear. For every Boeing, there are going to be more BlackRocks, Microsofts, Starbucks, and Airbnbs.

 

is head of sustainability research for Morningstar.

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