As the person who leads the organisation behind the finance industry’s main professional qualification, I am frequently questioned about how the investment profession can more clearly demonstrate its mission of fostering business growth and generating prosperity.
The bigger question underlying these concerns is a simple one: what is finance for?
One possible way in which our profession can prove purpose is through greater focus on environmental, social and governance (ESG) investing. ESG investing is growing in popularity but still divides opinion on its merits.
Some argue, for example, that applying ESG factors to investing constitutes undue activism and may breach an asset manager’s duty to focus solely on investment returns.
However, integrating material ESG data into the investment process is about taking a more complete approach to understanding the environment and social impact, both positive and negative, that a company can have on the wider world.
This reality is becoming increasingly clear to professionals in the financial markets, although we are, as yet, far from a consensus view on how to integrate these factors into formulating an investment thesis.
We must work harder to quantify the benefits of ESG investing, so that we can accelerate its adoption into mainstream practices.
A recent survey of CFA Institute members based largely in Europe, The Evolving Future of ESG Integration in Investment Analysis, reveals a growing conviction that the investment management industry has a responsibility to consider ESG information as part of its analysis.
In fact, a full 85 per cent of respondents now believe it appropriate for institutional investors to take ESG factors into account when making investment decisions.
The fact that a fund manager’s fiduciary duty is not compromised by the inclusion of material ESG data in the investment process needs to be reinforced.
Analysing any public company is not only about the potential financial returns to shareholders. It is about the social and environmental factors that both affect the business and that the company’s operations can also shape.
While these so-called externalities present challenges to financial analysts who are tasked with valuing them, ignoring them fails to account for the true cost they may have on society, the economy and, ultimately, on our investments.
Take smoking for example. According to a World Health Organization (WHO) report in 2017, smoking and its side effects costs the world’s economies more than $1tn every year.
Climate change will carry an even bigger cost to society. According to the UN Intergovernmental Panel on Climate Change, extreme weather and the health impact of burning fossil fuels have cost the American economy at least $240bn a year over the past decade.
This burden will rise by 50 per cent in the coming decade alone. By 2030, the report estimates that the loss of productivity caused by a hotter world could cost the global economy $2tn.
These are material numbers in any context. Timely, consistent and comparable information will allow governments and investors to set a proper price on the externalities that flow from a company’s operations for which it is currently not charged.
Fortunately, some in the industry are placing a stake in the ground: BlackRock is forecasting that the ESG investment market will grow 16-fold, from $25bn to $400bn, over the next decade.
Anne Richards, who over the summer was named as chief executive of Fidelity International, recently called for investment management firms to adopt ESG considerations as part of a much broader set of performance metrics.
Governments across Europe and the European Commission itself are actively considering how they can create an environment that promotes ESG considerations.
The next generation of investors, and a growing number in this generation, will not accept the absence of precise quantitative frameworks as an excuse for inactivity.
They are demanding that the investment industry responds to their desire to proactively address some of society’s most intractable problems. This will take vision.
Our profession relies overly much on historical data to inform its future investment decisions. This framework is not appropriate for challenges whose impacts are so difficult to quantify with certainty. Judgment and courage are required.
It brings us back to that question: what is finance for? Answering it to our clients’ satisfaction will mean showing them that it is for the ultimate benefit of society.
The tipping point for ESG is coming.
Paul Smith is president and chief executive of CFA Institute
Christopher K. Merker, PhD, CFA, is a director with Robert W. Baird & Co. Merker holds a PhD in Investment Governance and Fiduciary Effectiveness from Marquette University. He is a past president of the CFA Society Milwaukee and a current board member. An adjunct professor of finance at Marquette University, where he teaches the investment course, Sustainable Finance, he is also executive director of Fund Governance Analytics, LLC, a provider of governance research and diagnostic tools for issuers, asset owners and institutional investors. He publishes the blog, Sustainable Finance, which covers current topics around sustainability in investing (www.sustainablefinanceblog.org)