Sustainalytics is one of the world’s largest and best investment research firms specializing in sustainability. How did you get started in ESG investing?
Sustainability issues were always an important part of who I was, but I never saw myself working in the non-profit world, government, nor did I consider myself an activist. I cared about the environment and social justice. In practical terms, I was studying for some exams to become licensed by the Ontario Securities Commission and I happened to be listening to CBC radio and heard an interview of people doing ethical investing. That was it for me. It clicked: use money and investment capital to inform and influence corporate behavior. Now more than twenty-five years later we are finally feeling the tailwinds of sustainability in the investment space like never before.
How has the field of ESG investing changed over the past 25 years?
The industry has certainly evolved. When we look back 25 years, responsible investing was pretty rudimentary compared to today’s standards. Our clients looked at the world through a dual-lens microscope: financial return and values or mission.
And then in the early 2000s, we saw a number of corporate scandals such as Enron, WorldCom, Nortel, Parmalat, Olympus and more. These governance failures helped start a whole new conversation in the investment community. Chief Investment Officers would tell me, “Michael, I would never have believed that governance could have such an impact on shareholder value. And if governance could have this impact, then maybe there is something to this environment and social stuff too.”
So, these corporate governance debacles were the catalyst for a new way of thinking about ESG investing. By the mid-2000s, about 20 institutional investors came together under the auspices of the United Nations. They formed the UN Principles for Responsible Investing (now referred to as simply the PRI) in April of 2006. These new aspirational principles were based on an underlying belief that integrating ESG was a smarter way to approach investment decision- making. Today there are 1700 signatories to the PRI with $60–70 trillion in assets under management.
Climate, water and human rights were not just seen to be values-driven or ethical issues, but in fact these were increasingly understood to be meaningful business issues with the potential to materially impact financial performance. Investors were looking at all of this differently and began to see ESG as an important component of fiduciary responsibility. And today responsible investing is now arguably a mainstream phenomenon.
This is not to say all investors believe or practice ESG now, but the fact is there are a lot fewer people in capital markets globally that question the reasons that underpin why ESG is important.
This is a huge shift. When I started 25 years ago the argument was that, as an investor, fiduciary responsibility meant that I couldn’t look at ESG issues. Now this is almost the reverse. As an investor, if I am not looking at all potential risks, if I am excluding ESG issues from my decision-making framework, indeed I may be transgressing my fiduciary responsibility.
How much progress have we really made? Are we half way to truly sustainable investing?
I believe that responsible investment is out of our infancy and into adolescence and trying to figure out what we want to be when we grow up.
I say we are in adolescence today because, while looking at ESG as part of an investment decision is now a largely accepted part of contemporary investing, we haven’t fully figured out how to do this meaningfully yet. How can we ensure that responsible investing is really helping to identify risk or opportunities? How can we ensure that the insights we deliver through ESG can really lead to actionable insights for decision making? How can we ensure that the impacts of our investments deliver in a holistic way? It would be farcical to say that ESG is so deeply ingrained across all investors that we have maximized our positive impacts. We have a long way to go on that front and a lot of growing up to do.
But there is an interesting change that is going on – maybe too early to call a trend – but certainly a different vibe in the ESG space. As I said, 25 years ago the ESG movement was driven by investors who were motivated by values and a mission-orientation, followed by a decade that was about mainstreaming and how one can best optimize returns by looking at investment decisions with more rigour. During this mainstreaming, the pendulum swung aggressively away from a sense of mission or values. These concepts were lost or dormant for a while. I think we are on the cusp now of the pendulum swinging back to find equilibrium – a desire to not only consider how ESG issues impact your investment portfolio, but how your investment portfolio impacts society.
What is driving this shift in mindset among investors?
Climate change has been a huge driver of this. From an investor standpoint, the initial focus was on avoiding companies that were contributing to climate change, primarily for ethical reasons. Then it shifted to an understanding that integrating carbon analysis into the process could assist investors in making smarter and better decisions about which companies and sectors to invest in. Now it is expanding beyond simply security- and portfolio-level analysis as it is becoming increasingly clear that climate change introduces systemic risks that can have material impact on investment returns across all asset classes and investment horizons. If investors are not involved in addressing these at a systemic level, it doesn’t matter how smart they are and what their choices are, the entire system is under stress and vulnerable. Accordingly, an issue like climate change becomes an obvious systemic risk for the entire investment community.
And circling back to the conversation about the ESG pendulum finding balance, we are now beginning to hear pension funds say, “Of course we embrace Responsible Investing – it is the smart thing to do, it better positions us to fulfill the pension promise and is part of our fiduciary duty.” But our fiduciary responsibility also means we have to ask questions like what type of world do my plan members want to live in? What good is that pension cheque we deliver in 20 or 30 years if our plan members can’t eat the food, drink the water, breath the air or live in a safe community? This leads to connecting investment decisions to broader societal well-being and to things like the UN’s Sustainable Development Goals. This is the conversation we are just starting to see emerge, a little more in Europe than other regions, but still nascent.
Are you excited about the future?
Yes! Adolescence can be a time of turmoil and uncertainty, but it is also an exciting time. The possibilities are endless and there is boundless enthusiasm and energy. And I do see a lot of smart, passionate, dedicated people coming into the investment world.