What/How Series (2a of 6): How do we move beyond ESG (Environmental, Social and Governance) Investing?
“Last week Angela Merkel and Emmanuel Macron agreed to a €500 bn initiative to meet the human suffering from COVID-19. This convergence of interest reflected a commitment to the principle that Europe was stronger together than divided. On the same day, I had a conversation with a dear friend, living in Austria. Timothy introduced me to a discussion he was having about human capital, and the primacy of human capital as a source of financial performance for companies competing against one another. Timothy’s argument: by creating a positive corporate culture and by supporting employees, an enterprise could out-compete enterprises that didn’t.”
ESG investing grew from John Elkington’s thoughtful work in the mid-1990’s around triple bottom line investing. Today ESG investing is fully “main-stream” with the majority of mandates outside of the US being awarded to ESG-only investment managers. Here in the US, asset owners are picking up the pace, and we expect that COVID-19 will accelerate the movement to embrace ESG approaches with an increased focus on the “S”. Given that the US is playing “catch-up” with the rest of the world – why are we talking about moving beyond ESG?
Let’s look back before we go forward. Fifty years ago Milton Friedman gave us the Friedman Doctrine: advancing the interests of shareholders over any and all other stakeholders. Many of the middle aged men who carry the burden of “fiduciary” in our wealth management industry are faithfully carrying on Mr. Friedman’s legacy. Twenty-five years ago Elkington ushered in “sustainable investing”. The champions of investing to “do less harm” are ascendent based on the mandates that are being awarded: 80% ESG in Oceania, 50% in Europe and 30% in the US. Will this second generation of wealth owners and managers, embracing ESG, “save the people and the planet?”
We don’t think that doing less harm is going to save us. TILT is working with its clients to advance a new paradigm: regenerative investing, and we don’t think that we need 25 years to transform the investment landscape. To explore “the how” of moving beyond ESG, we might consider Einstein’s wisdom: “If I were given one hour to save the planet, I would spend 59 minutes defining the problem and one minute resolving it.”
So what’s the problem? Put simply ESG investors’ first care is achieving an above average risk adjusted financial return. ESG investment managers (working for asset owners) want to be in the first decile of their peer group - and that means earning higher financial returns than the market or a universe of other managers competing within an asset class. Regenerative asset owners want to earn a financial return that is based on the concept of “enough” - an absolute measure of their needs and goals. Regenerative investors also want to generate non-financial returns: regenerating the human, environmental and civic capital stocks that have been consumed by investors performing the alchemy of converting non-financial capital into financial return. These asset owners working with TILT are learning to develop and apply unique and highly customized investment strategies.
The asset owners who continue to seek financial returns by converting both human capital (causing rising rates of inequality) and environmental capital (causing rising rates of environmental degradation) into financial capital - albeit “sustainably” while “doing less harm” than conventional investors - are not going to “save the planet.” Investment managers applying ESG screens (developed over the last 25 years) to their investment process are simply maximizing financial return while reducing risk for their clients. Our collective interests require asset owners and investment managers with the curiosity and the courage to move beyond ESG thinking.
A hard look at the collective well-being of humanity and the earth’s current health reveal how much needs to change. The last 25 years have been terrible for people and the planet. COVID-19 has exposed the cracks in our physical and social infrastructure. For those of us willing to look outside of our bubbles we can witness nearly 100,000 Americans dying in the last three months from COVID. We can see the impact of cyclone Amphan on India and Bangladesh last week. For those of us unwilling or unable to raise our awareness and to see the fragility of our existence, conventional investment practices are just fine and ESG might simply make us feel better about the financial returns we are seeking. Risk mitigation is not going to regenerate human capital: e.g., reduce poverty or provide quality education. Sustainable investors who seek to “do less harm” will not reduce the frequency and magnitude of natural disasters caused by a changing climate.
The TILT multi-capital framework provides a new set of tools - moving beyond the ESG framework. Our approach to investing in enterprises and to building portfolios reflects a simple goal: we want to generate positive returns across four forms of capital: civic, environmental, financial, and human. We want to build portfolios that align these returns to meet a client’s unique purpose. It’s a new investment approach (based on decades of academic research), and it's predicated on spending time with our clients to define “the problem” (taking Einstein’s advice) and consulting with the communities themselves to arrive at investable solutions. We also embrace another of Einstein’s brilliant observations: “We cannot solve our problems with the same thinking we used when we created them.”
Old thinking (ESG) builds a case for doing less harm to reduce risk. This might mean buying shares of Total S.A. instead of Royal Dutch Shell Plc. when comparing the human suffering and environmental degradation these enterprises caused in Nigeria. New thinking goes beyond this. TILT and its clients are exploring a new frontier. We are working to generate both financial and non-financial capital returns, across asset classes. We work with our clients to do more than minimize environmental degradation. We seek to sequester carbon from the atmosphere, eliminate water and air pollution, and expand biodiversity. We care about more than employee health. We also care about the health of consumers and suppliers, together with the well-being of people that live in proximity to an enterprise. Finally, while we agree that strong governance is a critical factor in any investment decision, we want to understand how an enterprise generates civic capital. Can we measure an increase in municipal tax payments? What are the ways an enterprise commits itself to the needs and priorities of the larger community?
Put simply, TILT’s investments are made to change the status quo; we think and behave like we are on offense. We aren’t satisfied with slowing the pace of suffering and degradation; we aren’t on defense. We work with our clients to build portfolios across all asset classes that change the way things are - today and for tomorrow. Individual portfolios are focused on specific goals. Collectively, TILT portfolios seek to regenerate the critical capitals that have been exhausted.
We celebrate John Elkington’s work to launch the ESG movement, and the investors (during the last 25 years) that have pushed the frontier of conventional investing. The world is better for your efforts. We need to go beyond ESG investing to regenerate the capitals that have been depleted. To get there, we need new tools and fresh measures to calibrate our successes and our failures. Most of all, we need asset owners to embrace the challenge of saving people and the planet. Earning a “better” risk adjusted financial return is not enough. Let’s see if we can accomplish this in less than 25 years – our children will be grateful for our courage and our efforts!
“I respect that Timothy is working with people to develop a measure that values human beings (in order to increase profits). I worry that this incremental and self-interested thinking belies a full understanding of the larger problem we need to solve. Angela Merkel, responding to the COVID-19 crisis in collaboration with her peers, sees something much bigger than the short-term health of hundreds of millions of Europeans. She sees that the future of a unified Europe hangs in the balance, and that she must concentrate her courage and conviction to focus on the real problem.”