The Big Shift: Responsible Investment as Our Duty, Not Simply At Our Discretion

Oddly enough, our extremely legalistic world finds a vast majority of investment professionals facing this predicament:  They need the United Nations to help convince them (and their clients) it’s a good idea to understand the full spectrum of potential risks facing the financial system and to integrate that knowledge into investment decisions.

That may sound more like Corporate Finance 101 rather than an issue requiring the attention of a body simultaneously attempting to end extreme poverty by 2015, but a high level nod from the UN- and its team of lawyers and finance professionals- is what many asset managers and consultants need to get comfortable incorporating environmental, social, and governance factors (ESG) into decision making.

In its new report on the legal aspects of integrating ESG into institutional investment, the United Nations Environment Programme-Finance Initiative (UNEPFI) makes the case that fiduciaries of pension funds and other significant asset pools are well within their rights to look beyond traditional metrics of financial performance like PE ratios and cash flow statements when making investment decisions.  The initial report on this subject prepared by global law firm Freshfields Bruckhaus Deringer in 2005 concluded that “integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required.”

While to some this may seem so obvious that it borders on the banal, the truth is that investment professionals resist taking ESG factors seriously out of fear they are legally bound to focus on a more narrow, well-defined set of criteria to make investment decisions (enter ratios, balance sheets, and macroeconomic indicators).  We know these traditional metrics don’t tell us the whole story, but for many it is the story they know best and feel most comfortable peddling to their clients.

This new analysis by UNEPFI is “good work” because it supports asset managers and consultants who want to make the switch from a traditional, narrow view of investing to one that incorporates the vast environmental, social, and governance challenges of the 21st century.  And UNEPFI comes down out of the intellectual ether long enough to provide some important hand-holding and step-by-step advice on how to do that.  For example, providing sample language explicitly referencing ESG that is cut-and-paste ready for dropping into investment contracts.  While UNEPFI argues that such explicit references are not necessary in order for an asset manager to begin incorporating ESG into the investment process, clear reference in the contract would assuage the fears of many a money manager .

Fiduciaries can, understandably, be so focused on the perceived difficulties of adopting responsible investment strategies that they become blind to everything they have to gain from them.  This report invites them to test the waters of a new way to invest- it’s nice out here and I hope they start wading in.