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A Shift In Power: Clients Call For Greater ESG Consideration

Eliane Chavagnon

20 August 2012

A growing number of wealth management businesses are incorporating consideration to ESG factors into their practices, off the back of high investor demand and in a sign that the industry is seeing a transfer of power from firms to clients.

The premise that a blend of environmental, social and governance factors can significantly influence investment performance is certainly not a new idea. In a 2010 study by Accenture and the United Nations Global Compact, 93 per cent of some 770 corporate chief executives said sustainability would be “critical” to the future success of their firms, despite the economic downturn.

At the time, a “major barrier” CEOs cited to embracing more sustainable business strategies was a lack of recognition from the financial markets, says Dr James Gifford, executive director at the UN-backed Principles for Responsible Investment - a network of international investors collaborating to enforce six principles for responsible investment.

As part of the network, signatories to the PRI are encouraged to pool their resources together and engage with other firms. The initiative also promotes the collaboration of investors in addressing “systemic problems,” which the PRI says if tackled could ease financial volatility and reward long-term responsible investment.

In a sign that businesses are beginning to take sustainability more seriously, Dr Gifford explains to Family Wealth Report how in the last year alone over 300 signatories have engaged with at least one other firm on their approach to ESG.

Dr Gifford notes how there was a “huge increase” in private equity firms signing up to the PRI in the wake of the financial crisis - driven in part by a shift in power from private equity firms to their clients. “Private equity investors were demanding their managers to consider ESG issues in more detail, given their ability to materially impact the valuation of investments over the longer term, and the industry had to respond.”

The Social Investment Forum Foundation’s 2010 report on socially responsible investing trends illustrated that SRI in the US has continued to grow at a faster pace than the broader universe of conventional investment assets; between 2007 and 2010, professionally-managed assets remained “roughly flat” overall, while SRI assets on the other hand “enjoyed healthy growth.”

Flexibility and change

In an industry which has become increasingly “siloed” by style or geography, the flexibility to look across markets and subsectors over a significant time period is essential, according to Farha-Joyce Haboucha, director of sustainability and impact investing, senior portfolio manager and managing director at Rockefeller Financial.

Rockefeller Asset Management signed up to the PRI in June, and Haboucha explains how her firm’s heritage of sustainability and impact investing dates back to the 1970s, when the family office began integrating ESG factors into the investment process.

“Our commitment to the PRI represents a fundamental reinforcement of the investment and research practices that we have already established and followed for decades,” she says, adding that Rockefeller’s long-term focus allows the firm to “know” its companies and concentrate on the business and the strategy, as opposed to the next set of quarterly figures.

According to Haboucha, signing the PRI is important because it raises the visibility on the firm’s long-standing investment practices and the importance of ESG integration. “We also hope the continued expansion of the PRI network will promote further change in our industry. For example, most securities analysts today are not properly trained or incentivized to understand the ESG components that confront the companies they cover; conversely, most specialized ESG analysts tend to have little financial or business training.”

Likewise, she warns that, while there is a burgeoning interest in sustainability and impact investments, advisors may underestimate the work and commitment that such an investing approach requires. “For many advisors that lack either resources or a strong record in this area, the execution of sustainability and impact investing properly (and thus well) may not be the easiest way to increase their business.”


Meanwhile, a recent UK review suggested a movement towards a focus on wider factors than quarterly figures is much needed in the investment industry.

Professor John Kay's review, released last month, concluded that a lack of trust and poorly-aligned incentives have pushed UK equity markets into a culture of “short-termism,” undermining their role of supporting innovative and sustainable long-term business performance.

Although the report is specific to the UK market, the findings are relevant globally due to the international nature of investment markets, and are equally applicable to family wealth and related challenges in the US, Haboucha remarks.

The dangers of maximizing short-term performance at the expense of a more sustainable long-term approach “cannot be underemphasized,” Dr Gifford warns. Cutting corners in order to meet quarterly earnings targets undermines long-term investment performance, and can leave portfolios poorly-positioned for future risks and opportunities relating to issues such as resource scarcity, climate change and aging populations, as well as other social and environmental externalities which are “likely to be priced in future,” he says.


In terms of the most pressing ESG-related challenges, Haboucha ranks corporate governance among the top concerns.

“Corporate governance continues to be a major concern, due partly to the size and nature of the incentives involved in the management of many firms, and the effect those incentives can have on the long-term performance of a company,” she says. “Executive compensation and the separation of chair and chief executive are major issues in the US, but executive compensation is also taking on greater prominence in the UK and in other parts of Europe. We are also seeing interest in diversity, especially on boards of directors.”

Meanwhile, climate change and environmental worries are also climbing to the top of the agenda as people become more aware of the stress emanating from resource constraints.

On this note, Dr Gifford points to the PRI’s2011 Universal Ownership report, which revealed that the top 3,000 public companies rack up over $2.15 trillion of global environmental costs. According to Dr Gifford, the “key insight” from this analysis is that, for a diversified investor, environmental costs are “unavoidable,” as they manifest in the portfolio as insurance premiums, taxes, higher input prices and - in the case of carbon emissions and climate change - the physical costs associated with disasters.

Through the eyes of the investor

Rob Lake, who is also of the PRI, recently wrote: “We should also explore…how far it is in investors’ financial (and I stress financial) interests to encourage policy action to bring externalized sustainability costs on to companies’ books.”

Asked by Family Wealth Report how this could be achieved, Dr Gifford says a first step would be to quantify the costs of social and environmental externalities to the economy and investors. “With this information, it will be possible for investors and policy makers to respond with new or adapted investment strategies at the portfolio level, or public policy measures that seek to internalize these costs, and raise awareness of the impact of short-termism on asset allocation and investment returns.”

In terms of policy and regulation to shrink the gap between an investor's financial interests and what is “democratically determined to be in the broader public interest” - as highlighted by Lake - Dr Gifford believes that much boils down to investment timeframes. “The longer the timeframe, the more aligned investor interests will be with society.” Indeed, profits can be made by externalizing short-term costs, but as the Universal Ownership analysis demonstrates, externalities are “a zero-sum game.”