Background
In 2018, the Thinking Ahead Institute (TAI) carried out a research project to address the question: “how should the investment industry create value?”. With input from investment professionals across seven member organisations[1], full findings from this research are summarised in two research papers hosted on the Institute’s website: Connecting the dots: understanding purpose in the investment industry and Mission critical: understanding value creation. This briefing summarises key insights from our research.
What is the purpose of the investment industry?
The theory
We believe that the investment industry as a whole should be viewed as a complex, adaptive ecosystem[2]. In short, this implies that while the industry is made up of a number of connected and interdependent organisations (which compete with, and rely on, each other), these organisations are a product of, and an influence on wider society. In the same way that biological ecosystems have no governing purpose[3], an ecosystem perspective of the industry has two significant implications: (i) it is beyond the power of any agent, even a regulator or a government, to impose a social purpose on the industry, and (ii) if we want the investment industry to change, then we need to focus on what the industry does.
The practice
The above observations led us, as a working group, to look at some of the key functions of the investment industry to address the question of its purpose. In short, two of the most commonly observed functions of the industry are risk management (specifically the construction of portfolios to an asset owner’s risk budget) and stewardship activity. Risk management is primarily focused on managing cross-sectional, or point-in-time risk, and stewardship (arguably, across-time risk management) is gaining traction but can be done better. The often cited function of efficient capital allocation is observed to a much letter extent across asset classes.
Society is increasingly asking the investment industry to play its part through investing sustainably – balancing time horizons and stakeholders. The social licence to operate for all asset owners and asset managers is a tacit social contract that gives legitimacy to the industry depending on the impact of their actions on wider society. This licence is only maintained if organisations create value for these stakeholders.
Does the investment industry create value?
The theory
At the end of 2018, the Institute’s value creation working group settled on a definition of value creation:
Value creation is an increase in the stock of monetary and non-monetary resources used to create future wealth and well-being for stakeholders, as judged by observers, mindful of the passage of time.
This definition is packed with powerful insights. Perhaps the most important one to draw out here is that the value created by investment organisations affects a wide group of stakeholders that goes beyond shareholders, employees and clients, but also includes companies, wider society and the planet. In setting an organisation’s mission leadership, either implicitly or explicitly, creates a boundary between those stakeholder groups which benefit from the value created and those for whom value is destroyed.
We mention two additional insights from this definition. Harkening to the adage “beauty is in the eye of the beholder”, there is a necessary subjectivity in the determination of whether value has been created. Value creation cannot unilaterally be declared by the organisation undertaking the activity. Stakeholders will have their own perspectives on how organisations’ resources should be used and transformed to create wealth and well-being. And this value emerges, or erodes, over time. These signal the need for companies to develop strategies that focus on (1) anticipating, understanding and responding to stakeholder needs and (2) the development of long-term relationships. It also calls for companies to self-assess and be transparent in reporting how value is created.
The practice
It is difficult for us to unequivocally determine whether the investment industry has added value to the future wealth and well-being of the vast range of its stakeholders, over multiple time horizons. Instead, as a working group, we attempted to: (i) understand perceptions of the value added by the activity of the investment industry, using the viewpoints of investment professionals within it, and (ii) set out three practical self-assessment tools which organisations can use to better define, measure and monitor the value created.
There was a belief by the working group that the investment industry, in many ways, has contributed positively to society through the creation of wealth, providing risk management services and increasingly ensuring that capital allocated to companies is effectively stewarded. However, the results of a joint industry expert survey, conducted with the International Integrated Reporting Council (IIRC) in March 2018, suggested that there was substantial room for improvement, particularly in the articulation of the industry’s purpose and in understanding how value created is distributed among stakeholders. Participants observed that the industry continues to suffer low levels of trust, asymmetries of information between end savers and itself and, in many cases, misaligned incentive structures and mandates[4].
How should the investment industry create value?
As a working group we set out a bold vision for the industry:
The investment industry should aim to provide whole-of-life, whole-of-balance-sheet management for end savers. At a minimum, this activity should cause no harm, and will be truly valuable if it contributes to a world more fit to live in. As such, the industry has a duty to ensure its provision of new capital, and its stewardship of existing assets add value to the end saver, wider society and the planet both now and, as far as it is able, into the future.
Achieving this vision is likely to involve a broader interpretation of fiduciary duty than is currently practiced. It involves moving fiduciary duty from its current framing of risk and return to a broader interpretation that also includes impact.
In our paper, Mission critical, we also set out five guidelines for organisations that wish to report on their value creating activities and introduce a self-assessment framework and monitoring scorecard. However, overarching these tools we point to two necessary signatures of the value-creating organisation: (i) intentionality – aligning the organisation’s mission, policies and behaviours with its intention to create value for stakeholder groups and (ii) transparency – clarity in reporting value creating activity, narrowing the gap between stakeholder expectations and ultimate outcomes.
An organisation cannot be considered as independent from society or the environment. It will affect (and be affected by) both of them – for better or for worse. If we are to improve the value proposition of the industry, we as investment professionals need to be the drivers of that change. This can be achieved through a better understanding of our own purpose-driven motivations as investment professionals and how they collectively contribute to the well-functioning of our firms and the wider industry.