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February 22, 2012
Generation Investment Management Calls for Sustainable Capitalism by 2020
    by Robert Kropp

The firm expands upon a manifesto written by co-founders Al Gore and David Blood and calls for mandatory integrated reporting and the pricing of externalities, an end to quarterly earnings guidance, and loyalty-drive securities for long-term investors.


An essay included in the recently published Evolutions in Sustainable Investment: Strategies, Funds and Thought Leadership surveys the investment philosophy of Generation Investment Management, founded in 2004 by former Goldman Sachs executive David Blood and former US Vice President Al Gore.

The essay, authored by Malte Griess-Nega and Nick Robins, notes that by the end of 2010 the firm had attracted $6.6 billion is assets from institutional investors and high net worth individuals. By March, 2011, the authors found, the firm's Global Equity Fund "had delivered a positive 17.38% outperformance over the benchmark since inception in the middle of 2008."

The investment philosophy driving the fund's outperformance includes a long-term strategy; the firm recognizes that environmental, social, and corporate governance (ESG) factors affect the long-term profitability of companies.

Also, "Sustainability challenges are increasingly interconnected: the climate crisis and poverty, pandemics and demographics, water scarcity and migration/urbanization," the firm states. "We never consider sustainability challenges in isolation."

"Sustainable solutions will be the primary driver of industrial and economic development for the coming decades," the firm continued.

Yet, despite the success of Generation's sustainable investment strategy, capital markets in the US and elsewhere persist in maintaining short-term investment strategies antithetical to the long-term view of sustainable investment. And the vast majority of traditional socially responsible investment (SRI) fails to incorporate the rigorous and often expensive research necessary for sustainability to realize outperformance, Cary Krosinsky argues in his introduction to Evolutions in Sustainable Investment.

"While trillions of dollars are invested in a 'socially responsible' manner, upward of 90% of that sum has been deployed over time using unsophisticated screens," Krosinsky wrote.

Griess-Nega and Robins write in their essay, "Generation's vision of investment extends beyond its funds to the economy as a whole, where it aims to promote 'sustainable capitalism.'" An example of this promotion occurred in December, when Gore and Blood published A Manifesto for Sustainable Capitalism.

Gore and Blood do not mince words in describing the challenges requiring a global transition to long-term sustainability. "We are once again facing one of those rare turning points in history when dangerous challenges and limitless opportunities cry out for clear, long-term thinking," they write. "Businesses cannot be asked to do the job of governments, but companies and investors will ultimately mobilize most of the capital needed to overcome the unprecedented challenges we now face."

The authors define sustainable capitalism as "a framework that seeks to maximize long-term economic value by reforming markets to address real needs while integrating environmental, social and governance (ESG) metrics throughout the decision-making process."

The benefits to companies that embrace sustainable capitalism include increased profitability through sustainable products and services, improved energy efficiency, superior management of risk, and lower cost of debt.

"Sustainable capitalism is also important for investors," the authors continue. "Investors who identify companies that embed sustainability into their strategies can earn substantial returns, while experiencing low volatility."

Gore and Blood recommend five actions "by companies, investors and others to accelerate the current incremental pace of change to one that matches the urgency of the situation."

The risk from stranded assets, which are described as those whose value would change dramatically should externalities be priced, should be identified and incorporated. Integrated reporting—the practice of embedding ESG information into corporate financial reports—should be mandated. Executive compensation should be linked to long-term sustainability performance.

Gore and Blood also recommend two actions designed to eradicate the short-termism that "fosters general market instability and undermines the efforts of executives seeking long-term value creation." Companies should issue loyalty-driven securities that reward investors for holding onto shares over the long term.

And, the authors state, companies should "end the default practice of issuing quarterly earnings guidance."

Earlier this month, the London office of Generation published a report entitled Sustainable Capitalism, a document which builds upon the positions espoused by Gore and Blood. "Sustainable Capitalism encourages us to generate financial returns in a long-term and responsible manner," the report states, "and calls for internalizing negative externalities through appropriate pricing."

"Asset owners and fund managers with US$30 trillion in assets under management, which is approximately 20% of the world's capital are signatories to the UN Principles for Responsible Investment (UN PRI)," the report observes. "If the majority of those assets were actually shifted into truly sustainable investment models, the effect would be dramatic and would signal that Sustainable Capitalism is entering the mainstream."

The report repeats the recommendations of Gore and Blood in their manifesto, but also addresses the responsibilities of governments and civil society to help bring about a transition to sustainability. In addition, the report includes five additional ideas deserving of greater attention.

Sustainability as a fiduciary issue should be reinforced, and investment consultants must include in their advice to clients the financial materiality of sustainability factors. More sustainable investment products should be developed for asset classes other than equity. Sustainability should be included in the education and training of corporate managers and executives, as well as consultants and investors.

The report also calls for a reevaluation of Gross Domestic Product (GDP) as an accurate measure of economic growth, arguing that it "must be reconsidered in the context of consumption, income distribution, and quality-of-life indicators."

"The barriers to mainstreaming Sustainable Capitalism are formidable but not insurmountable," the report from Generation concludes. "We believe that the actions for change we are recommending, taken together, will affect the entire business ecosystem and encourage reform by investors, companies, government and civil society alike to adopt long-term horizons and consider ESG factors in addition to financial ones."

Underscoring the urgency of Generation's message is its call for the adoption of sustainable capitalism by 2020.

 

 
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