Responsible Investing: Challenges and Potential

Guest Blog Post by Sarah Stephen , University of Lausanne 

"Finance, despite its flaws and excesses, is a force that potentially can help us create a better, more prosperous, and more equitable society".
Thus writes Nobel Economics Laureate Robert Shiller in his book "Finance and the Good Society", one which reiterates his call for utilising the tools of finance for the greater good of society. I consider responsible investing to be one such tool. This has been employed in various guises, most notably over the past four decades, to construct a better world by incorporating environmental, social, and governance criteria in investment portfolio selection and management. Many are the investors practicing this philosophy and many the financial services firms offering such products. In fact, the Global Sustainable Investment Association claims this as amounting to USD $21.4 trillion at the start of 2014. This prominence being catalysed by advances in information technology, globalisation, and the increasing role of civil society, newcomers in this field have their task cut out. Yet, it was not so for the front-runners who confronted a field where the dominant worldview was Friedmanesque insisting that "There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."

The perils of trailblazing
Triodos Bank, the Dutch ethical bank, was one such notable trailblazer which, when launched in 1980, experienced the perils of swimming against the tide. "Investors were not ready", observed Hadewych Kuiper, of Triodos Investment Management. Even a fast forwarding to 2012 in Switzerland does not efface such challenges: Credit Suisse faced such hurdles when placing such products as the topic was very new for a mainstream, global financial player. The same was encountered by J. Safra Sarasin Ltd, the Switzerland-based sustainable private bank, when launching their products over 2 decades ago. Far from a first mover advantage, the bank faced a first mover disadvantage. Pieren Menzli enumerates these as "awareness raising in the market place, education and training, fulfilling many different needs, e.g. reputational risk reduction, performance enhancements, engagement, at the same time in one investment strategy".
The trailblazers’ perseverance paid off to the extent that responsible investing (regardless of the veracity of the figures stated earlier) is a growing investment philosophy. Although most responsible investing strategies are considered as being mainstream, the newest strategy, i.e. impact investing, is facing many of the same challenges faced by the responsible investing movement in the 1970s-1990s.
The first challenge concerns investors. To begin with, there is, as conveyed by Credit Suisse’s Olivier Rousset, "a paradigm mismatch that needs to be matched". On one hand, the financial profit maximisation paradigm; on the other, the numerous values behind the investors' preference for responsible or impact investing. Secondly, as identified by Kuiper and Tenke Zoltani of UBS, there is a lack of seasoned investors. Potential investors are unaware of impact investing and all that this entails. Acknowledging that powerful investors (such as pension funds) are crucial, Dominique Habegger, of de Pury Pictet Turrettini & Cie, directed my attention to the pension fund participants at the TBLI conference in Rüschlikon. The fact that this set of investors was all but absent speaks volume. This possibly might be an outcome of an a priori perception that such products are risky and not sound investments, as voiced by Rousset, or incompatible with their investment philosophy. This absence, however, maybe a spurious correlation as Christian Etzensperger, of responsAbility, counters that institutional investors are the significant investor population in their funds (accounting for more than 50% of the $3 billion). Yet, adopting such alternative strategies requires changes in the pension funds, particularly by becoming less conservative, less bureaucratic, and less risk averse. Alternatively, instead of focussing on strong-arming such powerful investors, more receptive institutional investors could be approached, these being, according to Menzli, "families, foundations, UHNWI’s and to some extent PRI signatories among insurance and pension funds". Considering the lack of viable investors, Arthur Wood, of Total Impact Capital, pinpoints global foundations, one that he observes are essentially "asset management houses". Estimating around $3 trillion sitting in such foundations, around 99% of which is unaligned with social missions, there is a substantial potential in directing this capital and aligning this with social missions.
The second challenge, interestingly, lies closer to home for financial services firms. The first point of contact at a financial services firm holds sway in encouraging or dissuading potential investors. Personal experiences at a local bank evidenced how client advisors were either counselling against investing in dedicated responsible investment funds ("too risky", "underperforming") or were unaware of the existence of such products. Recognising this, UBS has been training client advisors on impact investing.
The third is both a challenge and an opportunity: the presence of competition. On one hand, this enables financial services firms, such as Credit Suisse, to offer products in conjunction with third parties, such as responsAbility. Etzensperger finds the competition to be friendly; not competing for investors, but for investment opportunities. Such arguments notwithstanding, Rousset admits that there is no option of sitting on laurels as the peers catch up. There is a pressure to innovate and to be distinct in a pool of competition, notes Habegger.
And, finally, Rousset's "paradigm mismatch" applies to the financial services firms offering such investment products. The recent financial crises and banking scandals has resulted in increasing scepticism about the motives of a financial services provider. In fact, according to the 2014 Harris Poll, nearly 45% considered the financial industry as having a negative reputation (the other two sectors with worse reputation being the government and tobacco industry). Given the scepticism of the populace, the products are rejected based on the provider's perceived lack of credibility.

Finance and Society
Shiller voices the truth when claiming that financial services, even with all flaws, are the stewards of wealth. The flaws in the sector have its own advantages as identified by Wood when he concludes that "the inefficiencies of the (financial) sector are, in some senses, the opportunity of the sector". The financial services have the required banking skills and, given the structural inefficiency of the sector, they can benefit from the substantive commercial opportunity and reduced reputational risks. On the other side of the coin, the involvement of the financial services will result in applying products, tools, and networks, thus benefitting the wider society and enhancing social performance.

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