Investment as Usual is Broken [Part 2 of 3]: who is doing the math?

Further thoughts from comments I prepared for “Investment as Usual,” for the launch of the Survey of Responsible Investment in South Africa, 2 October 2007 at Johannesburg Securities Exchange, Sandown, South Africa.Key components of the investment value chain are addressing the breaks, however slowly and tentatively. Indeed, as far back as 2004, Morgan Stanley equity research stated “understanding corporate governance is critical to investing in telecom”, but evidence of impact on decision-making is scant.

In generating investment ideas, the Enhanced Analytics Initiative [EAI] is designed to use the ordinary business of the brightest investment minds who offer best investment research ideas, but explicitly including ESG factors. EAI is a consortium of buy-side funds [investment managers] allocating commissions to encourage ESG research. EAI, including BNP Paribas, the Universities Superannuation Scheme, Investec and Hermes, have agreed to spend 5% of brokerage fees with firms that focus on ESG indicators. The EAI has over thirty representative investors with just under US$4 trillion asset under management [AUM].

The EAI next meeting is 29 Jan in London, hosted by Investec, the mid-size investment manager that I watched grow during my retirement fund consulting days in Durban and Johannesburg thru the 1990's. In my view their South African roots mean they understand the gritty reality of sustainable development and balancing ESG and investment on any given Monday. The sustainability reporting itself has moved a long way up the lifecycle, to a point where no separate Investec CSR report is issued. The EAI six-monthly cycle is up, and an update to the assessment of the best sell-side research should be forthcoming on the website soon.

A pressing question from the latest iteration of the Carbon Disclosure Project [CDP] is: with all the carbon information disclosed, what are investors doing with it? 2007 saw the fifth iteration of the Carbon Disclosure Project Fifth [CDP5], with information on corporate carbon footprints supported by 284 signatory investors representing $41 trillion of assets under management, demonstrating a significant uplift from 2002 (35 investors representing $4.5 trillion). This largest collaborative investor engagement includes blue-chip institutions across all continents including HSBC, JP Morgan Chase, Bank of America, Merrill Lynch, Goldman Sachs, AIG, State Street, Allianz, Credit Suisse, Munich Re, Mitsubishi UFJ, Mitsui Sumitomo, AMP Capital, Swiss Re, Rabobank, ABP, CalPERS, Hermes.

But a question with seldom a direct answer is: but what are investors doing with the information? My first hand experience with shops in Manhattan, Boston, London, Geneve and elsewhere is: not much. A simple question I put to my MBAs at Kenan-Flagler is - at what price are analysts that cover Southern Company [SO] or Duke Energy [DUK] factoring in carbon emissions in their valuations today? Browse their investors page, and keep the coffee in the travel mug, it'll probably be getting cold.

With electric utilities having huge capital costs for new projects or development necessitating decades long investment horizons, it is unclear currently how investment analysts deal with the material impact of CO2 emissions and costs of green house gas emissions. Are SO or DUK even reporting to their shareholders on their green house gas emissions?

Investment as Usual is Broken [Part 1 of 3]: Valuing ESG factors in equity analysis

Investment as usual is broken. The emergence of environmental, social and governance [ESG] factors in the twenty-first century has challenged the core of business thinking and strategy. Corporations are changing, sustainability has risen to the level of the C-suite, P&G recently appointed their first “Corporate Sustainability Officer”. But the “Chief Sustainability Investment Officer” is much further off. WSJ covers this amongst other "title inflation" items in Dec

Enhancing current investment analysis by integrating material ESG factors will offer better pricing of future risks and opportunities.

Global financial stock now stands at US$140 trillion and growing, according to McKinsey, 2007 based on the latest 2006 data. The value of total global financial assets—including equities, government and corporate debt securities, and bank deposits—expanded to US$140 trillion by the end of 2005, an increase of $7 trillion from a year earlier . But many of the investment decisions are being driven by decision-makers who completed their studies before Google, more influenced by Gordon Gecko of “Wall St” than Al Gore! The sea-change in the way corporations are facing up to our changing world has yet to catch up to the inertia of investment professionals on Wall St, in the City of London and other major investment centers. Investment as usual fails to integrate ESG factors properly. I'm more open for entertainment though - word is there's an update to Wall St, and heck in the past 20 years, cannot say there's no material.

It has become accepted wisdom that “business as usual” will inexorably lead to humans consuming more than the carrying capacity of this one earth’s natural resources, from fossil fuels to potable water to clean air. Investment as usual – the practice of investment management - needs to make a similar adjustment as companies are making in assessing a sustainable future. Matthew J. Kiernan, founder of Innovest Strategic Value Advisors, says traditional financial analysis captures only a quarter of a company's risk and competitive profile. Risk-adjusted returns must reflect a broad and long-term understanding of materiality, within the bounds of fiduciary duty and applied across portfolios and asset classes.

In July, 2007, the United Nations Global Compact annual event keynote address was made by Goldman Sach’s Anthony Ling on behalf of the financial community . It is also true that Hermes has led an engagement on iron and steel companies in the Brazilian supply chain slave labour case. Goldman Sachs presents ten reasons for incorporating ESG factors, three of which were i. experience with risk and return balance, meeting liabilities including identifying global social and environmental challenges, e.g. secure energy supply, climate change, water shortages, BRICs growth, and increasing awareness of ESG issues by analysts and investors. The Goldman Sachs analyst team based in London released a 179-page equity research report titled "GS Sustain" in which it recommended 44 companies based on a combination of companies' ESG performance and fundamentals.

Goldman argued that its picks based on this formulation, both in the U.S. and abroad, outperformed the Morgan Stanley Capital International World Index by 25% over the past two years. A neat approach to selling the quality of your investment ideas. It has been wonderful to watch the London-based team grow from just 2 in 2005, to about 8 now, with more attention from institutional investors than even the GSAM itself. There's an old legend about leaving to find you way, and getting respect in foreign lands, no? Abbey Joseph Cohen will be interviewed by Maria Bartiromo on WSJR next week, maybe it will come up and give the initiative a push...

A recent report by McKinsey indicated investor community ranked only ninth amongst factors leading corporate managers to address societal concerns now and in the next five years. CEOs ranked employees as the stakeholder group that has the greatest impact on the way companies manage their societal expectations. The 391 CEOs surveyed representing 230 organizations in Private/Public, State-owned & NGOs. 90% of company CEOs participating in the United Nations Global Compact said they are doing more than they did 5 years ago to incorporate ESG factors into their strategies. Socially irresponsible business practices might make it harder for companies to attract and retain talented people.

But where is the voice of the investor?