Category: Publications

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A mission-driven investment (Marquette Biz)

When Dr. Chris Merker began teaching ESG — Environmental, Social and Corporate Governance — at Marquette in 2009, his classroom was filled with blank stares.

“People didn’t really give it too much thought back then,” Merker says. 

By this point, Merker, a director of Private Asset Management at Robert W. Baird & Co., had been thinking for years about ESG. The U.S. had recently been through two economic downturns, and Merker had been trying to understand why. When he first heard about ESG, around the time the United Nations founded its Principles for Responsible Investment initiative in 2005, he thought that between a growing list of corporate governance failures and rising stakeholder concerns, perhaps it could offer a window into why the world was struggling.

ESG is far different from traditional accounting. Accounting is typically viewed purely from financial statements — an organization’s value on paper was its true value. But, according to research by Ocean Tomo, over the past 50 years, the market value of companies has become increasingly disconnected from its book value. ESG has fostered new ways to understand factors that don’t show up on a financial statement — including reputation, relationships with employees, and how an organization may have exposures to growing environmental risks. 

More than a decade later, Merker says everything has changed. He no longer receives blank stares when discussing ESG, which has morphed into a new language of accounting standards and metrics. This is a language that corporations, investors and students alike are all scrambling to learn. 

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Short-termism Revisited (CFA Institute and Fund Governance Analytics)

Improvements made and challenges in investing for the long-term

In 2020 CFA Institute convened a panel revisiting the topic of short-termism and commissioned Fund Governance Analytics to quantitatively analyze the issue as we found many companies reluctant to step away from the short-term earnings guidance game.

https://www.cfainstitute.org/en/advocacy/policy-positions/short-termism-revisited

Overview

Issuers and investors have begun to understand the importance of issuer–investor communications in getting both sides on the same page on many long-term strategic issues. In the years since our 2006 report was published, investors and issuers have increasingly invested in resources dedicated to fostering engagement. Both parties realize that building a trusting relationship can increase understanding and avoid the adversarial relationships that often existed between the two groups in the past.

These improvements in the short-termism and long-termism landscape should indeed be celebrated, but more work remains to be done. Many companies have traded in short-term earnings guidance for either long-term guidance or a more diverse set of metrics that better informs investors. 

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The Proposed DOL ESG ERISA Regulation and the Public Reaction (Albert Feuer, Yale)

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3669462

ERISA plan fiduciaries select investments to make (1) directly on behalf of plan participants and beneficiaries, or (2) indirectly on behalf of plan participants and beneficiaries by selecting investment options to offer them. The DOL describes ESG investments as including socially responsible investing, responsible investing, and sustainable investing (ESG/sustainable investing). The DOL proposed regulation would direct those fiduciaries to look askance at ESG/sustainable investments. In particular, the proposed regulation would provide that

(1) ESG/sustainable investments are only permitted if the plan fiduciary overcomes burdens not applicable to other investing approaches regardless of the economic value of the investment, and 

(2) ESG/sustainable investment alternatives for self-directed plans, regardless of their economic values, may not (a) be a qualified default investment alternative or a component of such an alternative, or (b) include alternatives if the fiduciary acknowledges having used any ESG/sustainable investment considerations that are not “objective risk-return criteria.”  

Many commenters suggested that the proposed regulations be significantly revised, and there appeared to be broad agreement on two revisions:

• The regulation should permit an investment alternative may be a qualified default investment alternative for a self-directed plan regardless of whether the alternative makes any use of ESG/Sustainable consideration, such as using the S&P® index; and

• The regulation should distinguish between the use of ESG/Sustainable considerations to determine the economic value of an investment, i.e., the incorporation approach, which may be judged in the same manner as any other valuation tool, and cases in which consideration are used for other purposes.

There was a strong factual disagreement about whether ESG/sustainable considerations are only used to value investments, including as a risk-management tool, in which case there is no reason for any special scrutiny of those considerations. If those considerations are ever used for other purposes, such as to have positive effects for the environment, society, or enterprise governance, some argue ERISA not only prohibits such consideration, but special scrutiny is needed to avoid these so-called abuses. even if the pursuit of those goals does not reduce the economic value of the plan’s investment or plan’s choice of an investment alternative to make available to plan participants and beneficiaries. 

There was also a strong legal disagreement about whether the regulation should, as it does in very narrow circumstances, ever permit fiduciaries to use any ESG/sustainable considerations that do not determine an investment’s economic value to decide between direct investments which have the same expected economic value. 

The paper argues that it is advisable for the DOL to revise the proposed regulation to be consistent with ERISA, the usual practice of prudent ERISA fiduciaries exercising due diligence in making plan investment decisions, prior DOL guidance, and the reasonable preferences of many ERISA plan fiduciaries, participants, and beneficiaries to reflect not only the commenters’ broad consensus but also :

• Delete any additional reporting or review requirements on ERISA plan fiduciaries that the rule would impose only if the name of the investment and/or the investment approach includes an ESG/Sustainable reference;

• State that because multiple options often have the same best expected economic value, ERISA plan fiduciaries making investments need not, and often may not, consider only the investment’s expected economic value ; and

• Permit, but not require, ERISA plan fiduciaries to choose and retain “ethically beneficial” investments that do not sacrifice any economic value by using any non-pecuniary consideration to select or monitor investments if such consideration is not illegal, and does not reduce the expected economic value of the investment.

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The Trustee Governance Guide is now out!

Our new book, The Trustee Governance Guide: The Five Imperatives of 21st Century Investing is now available!

  • Focuses on both structural and process factors of governance
  • Covers related investment topics in each chapter, including fiduciary duty, financial literacy, asset allocation, and socially responsible and impact investing
  • Draws from the annual U.S. Public Pension Governance Survey and other leading industry and academic research
  • Includes special “practitioner sections” in each chapter geared to the more technical reader

More than 80% of the financial assets in the United States fall under the purview of a trustee. That’s a big responsibility for an estimated 1% (around 1.5 million people) of the U.S. working population charged with overseeing investments for millions and millions of beneficiaries, public sector, and non-profit organizations. In a world proliferated by investment products, increasingly dominated by indexes, faced—particularly in the pension world—with increasing liabilities, more regulation, and a growing number of social and sustainability objectives, what’s a trustee to do?

The Trustee Governance Guide is here to help guide today’s board trustee through the brave new world of 21st century investing. The book focuses on the critical aspects of the Five Imperatives: Governance, Knowledge, Diversification, Discipline, and Impact. Based on more than a decade of research, practice, and discussions with many key decision makers and influencers across the industry, this book addresses the many topics related to better governance, greater mission-driven financial performance, and impact. The questions the book addresses include: 

  1. What is good governance, how do we know it when we see it, and why does it matter?·      
  2. How much knowledge is necessary to be a competent board member?
  3. How big should my endowment be?
  4. What are the key elements of a diversified portfolio?
  5. How much does cost matter?
  6. What’s the difference between socially responsible and ESG investing?
  7. Can I focus on sustainability and still be a good fiduciary?

This book provides a way for boards to improve and benchmark their own governance performance alongside their peers, and uniquely covers related investment topics in each chapter.