The returns investors need can only come from a system that works
A notable outcome from 2018 was increased sensibilities on climate change both across society but also in the asset owner and corporate world. How the asset owner is framing the climate change issue was the subject I addressed in the article below, taken from the OP Trust Climate Change Symposium. This event was expertly convened to deepen the understanding of a difficult subject and get asset owners aligned to actions that are legitimate, proportionate and effective.
Keynote from Roger Urwin, Global Head of Investment Content, Willis Towers Watson |
OP Trust Climate Change Symposium Toronto | 19 November 2018
It’s a privilege and honour to be here. And many thanks for enabling my escape from the Brexit pit of misery – a case of values awry, common sense missing, liberal democracy unworkable and politicians just mean and nasty.
The spectacle from our House of Commons – MP after MP laying into our resilient Prime Minister is truly our tragedy of the commons, in which the freedom of opinion has squeezed out the quality of thought.
That’s not what I’m talking about today. I am going from a tragedy of the commons to a tragedy of the horizon, and our Mark Carney and his phrase for the climate challenge [i] and the finite and shrinking window of opportunity to address it, ouch.
This talk has an asset owner focus. I’ll try and mix content with a bit of brevity. And I am calling out four action points of ‘WISDOM’ – what I should do on Monday. And one killer fact – watch for it – that I hope sends you home wiser, which in a world of fake facts is a bonus.
I have the privilege of working with many of the world’s largest asset owners. OP Trust is one of the best examples of course. The asset owners of the world invest over $10,000 for every adult alive on the planet[ii]. I’ll start with a powerfully simple idea that they are increasingly expressing.
1. The returns investors need can only come from a system that works
I’ll explain a bit more. We live in a complex ecosystem – think of Kate Raworth’s doughnut here [iii]– the inner ring of social foundations and the outer ring of planet, containing the doughnut itself – the healthy society. Never before has the need been greater to understand that ecosystem and work in a savvy way with the grain. To achieve a balance – well expressed in Chinese yin and yan.
2. Right time for investors to do the right things to address that
I increasingly hear from asset owners that the right thing to do is investing sustainably, balancing time horizons and stakeholders. I contend it’s the right time for investors to play their part in achieving this balance for several reasons.
First, it’s that society is asking this of us. The social license to operate for all asset owners and asset managers is the tacit social contract granting legitimacy to asset owners. After all, we as individuals may or may not have our money managed by them, but we certainly feel the effects of their investment footprint – for better or worse.
Second. This is a planetary crisis with a diminishing window to avoid the train wreck outcomes that are visible ahead. In my nightmares, I see this train cab in which a bunch of people are at the controls, but most are looking out the side window. No pressure, but in my opinion we look like we are on a pathway to the mother of all train wrecks. There is a right thing to be done here.
Third, asset owners now truly get it that the returns they need can only come from a system that works. And the benefits they pay will be worth more in a world worth living in. We are in the fortunate position that we can do the right thing and be successful financially.
3. This is the universal ownership concept
Universal ownership is when investment organizations (and the assets they invest in) integrate their wider purpose alongside their profit motivations. Dollars and financial impacts lie in the dominant position but real world impacts count as co-benefits alongside financial benefits and ESG and sustainability principles kick in.
Big asset owners are getting better at what they do and becoming more influential, and are adding focus to longer-term value creation and sustainability. They are working together in a club of sorts. And they are acting on this mantra: ‘the returns we need can only come from a system that works needing us to address the co-dependencies of the economic, social and environmental factors.
Universal owners are large-scale, long-term, leadership-minded funds that invest in a hyper-integrated way* – E.g. New Zealand Super Fund, GPIF, CalPERS, OP Trust.
They manage the value and utility of member wealth integrating financial and extra-financial exposures over the short-and long-term, integrating financial and real world impacts. This is a bigger mission than they’ve worked to in the past and needs an upgrade in investment model.
What we need is for asset owner to adopt the Universal Owner re-purposing to meet participant goals while respecting wider stakeholders in an accountable environment applying hyper-connected principles. Action item 1
4. That will follow S-shaped paths applying T-shaped skills
How will they do this? We need some fresh, shiny, innovative answers and the good ones go through a lifecycle and a test of time that is an S-curve – they start small with innovation; they get a big bigger with some early brave participants; they get socialized, they form a network effect, they grow and pass the point of inflection when a lot of people buy-in. We are early in this sustainability S curve but it is pointing upwards and it’s accelerating because important organisations and leaders are joining the band-wagon.
But its future will depend on our ability to deepen our perspectives and our accompanying cultures here. The complexity in sustainability make it hard for anyone to be a master of this system. But the best people do build on their specialisation (the vertical ‘I-shaped person’) and add to it the wider context (the horizontal line of the ‘T-shaped person’). T-shaped people connect dots well, connect well with other people and are critical to our ability to thrive in the future.
A great example here is Mark Carney whose T-shapedness comes from wide experience and mindset as exemplified by the tragedy of the horizon thinking and his ability to be at home with any financial or non-financial context (‘Carney at home giving views on topics ranging from Scottish independence to Bitcoins and bank bonuses’ – FT coverage of Davos World Economic Forum – January 2014).
But we are struggling with being T-shaped in our hyper-specialised world of siloes. All organisations should be training their people more this way as a point of culture.
Action item 2: The 10% T-shaped learning rule – the key is that your job is spending 10% of your time on a lateral agenda in the present to build the ability to thrive in the complex future. Climate science, anthropology, brain science, data science, game theory – could all be part of that program.
5. This requires investing to undergo its own transformation
Sustainability and long-horizon investing are currently practiced by asset owners in a relatively shallow way. While most asset owners are in a position to take longer-term positions, imperfect mind-sets and misaligned incentives frequently get in the way. A soft fact – the commitment of resources in the industry to stewardship and active ownership is less than 1% of all resourcing. That can’t be a sensible figure.
We often lack the set of sustainability beliefs that are needed to drive your investment model forward here – the principles and assumptions about what we hold to be true across the spectrum of issues in front us; here both our context and our content that guide our actions and decisions. OP Trust has some nice stuff here.
The transformation is to use beliefs and further thinking to engage, allocate to risk, hedge, maybe even divest in the sustainability area. So example: Hedge = Investors allocate capital to investment strategies specifically designed to perform well in a low-carbon economy.
Such as companies involved in energy efficiency, renewable energy and clean technology to capture upside potential of climate change, employing beliefs as likelihoods not certainties that comprise the ecosystem. And engaging.
Sustainability and ESG are newish disruptions. Technology and data are playing a big part in this area. The subtlety is that big data in ESG is a lot more about so-called soft data or soft facts than the classic sort – basically information that is indirectly observed and in need of interpretation and its provenance is critical – think accuracy, biases, and materiality.
Let’s try an example of a critical belief. The one I want to try is this strawman: ‘The financial impact of climate change in investment outcomes over the next 20 years will be ‘negligible, moderate, substantial or extreme’. In WTW research work[iv] with 40 investment organisations and a sample of 550 investment professionals, 12% said they didn’t know, and the spectrum ran 6%, 30%, 44% and 8%. In my view 8% had the good answer.
6. Scenarios and narratives are critical
Scenarios and narratives are arriving on this scene. To overcome the prediction challenge, we should focus on understanding what could happen, instead of trying to predict what will happen. Scenarios are a great tool to explore strategic choices.
Investment decision making is largely about group decision making, which requires ideas to be effectively communicated. Stories and narratives are much more effective when communicating than facts and numbers. Narratives can provide a more systematic understanding of why things happen and how they are connected to each other. Anyone working in complicated space has to complicate to understand, simplify to act. We have action item 3 – the scenarios and narratives uplift
What are the features of the best scenario and narratives? A recent example I really like is a William Nordhaus podcast[v] for New York Times. For climate you have to connect dots by being T-shaped for understanding and brutally simple for communication.
1. Climate change issues and landscape
Climate outlook, current level of change and natural trajectory; other impacts like population migration
2. Climate change policies/interventions/influences
Paris and what follows; carbon pricing; science and technology; societal zeitgeist and media evolving
3. Fund landscape and climate connections
Exposures to physical risks and transition risks; mitigation costs; catastrophe costs and responses
It’s a lot. Many of the back stories to this are how much we are producing dots (impacts) and yet how badly we join the dots – understand the seriousness of the issues and the non-linear impacts which brings increasingly extreme weather down the pipeline; and the inter-connections residing in food and water security; population displacement; land degradation and coastal erosion.
7. The new investing model will take skill and judgement, data and technology
The new investment model – a paradigm shift – comes in these points:
- Mitigate Risk = reduce exposure to stranded assets and long term environmental risks
- Capture Disruptive Opportunities = increase exposure to companies providing environmental-friendly technologies and solutions
- Promote Stewardship = shifting behaviour of companies to develop sustainable long term strategy
- Index methodology = a strategy building block to help investors access opportunities and manage risks
- Drawing on a data lake = extending the sources of data, both hard and soft , to provide the scientific underpinnings
- Innovation = an exploding list with examples – climate scenarios, energy transitions, prediction markets, Total Portfolio Approach, catastrophe modelling
But it’s going to be hard and again it’s going to need T-shapedness.
8. Try to complicate to understand, but simplify to act
We have to do some hard work to understand this. The significant problems cannot be solved at the same level of thinking with which we created the problem was Einstein’s suggestion.
I firmly believe that the future presents a stream of seemingly insoluble problems that conceals a torrent of opportunities. This is desperately exciting for good people that can apply T-shaped thinking and leadership to what they do. We have moved investing from a 2 dimensional state risk and return, to a 3 dimensional state with impact in the mix – that’s complicating.
In this leadership opportunities, the pathway is about letting 100 asset owner flowers bloom together.
And we have to build better connections between like-minded organisations. There is an increasing pay-off to scale in stewardship. Ride the S-curve. Get others seeing things the way you see them. Build the asset owner network. And chip away.
By approaching problems with what might make things a bit better, not setting yourself up with how to solve this mega-problem. Exploiting T-shapedness in understanding..
9. Understand how our feelings and thinking clash
Here is a quick primer on some new research. This work draws heavily on Jonathan Haidt – Righteous Mind[vi] and Francis Fukuyama – Identity[vii]. This is T-shapedness in integrating attitudes and behaviours.
Haidt first. Our actions as people depend more on moral emotion than moral reasoning – feelings first. And feelings are generated by the need for respect for self-identity or ‘coherence’ motives (preserving a coherent and worthy identity and sensible worldview); and ‘relatedness’ motives (relating to managing impressions of your identity with others such that they give you respect; e.g. you want to manage your image in a team context and you want to be included and appreciated, a big issue for team effectiveness).
The thinking and reasoning process has repeatedly been shown to be used to create post hoc justifications for behaviours that are not actually correctly describing the reason underlying the choice (e.g. in the US climate change beliefs correlates massively with political preferences and ‘fake facts’ often backfill the justifications for those beliefs).
So the place in the middle for socialising. The gap between thinking and feeling can only be reached by the people in the inner ring of respect. The problem here is that social media is often where people turn to feed their feelings.
Not politicians, ha. More like the people you respect because you share their values and beliefs. Feelings first, socialising second, thinking third. Feelings trump thinking.
Now the Fukuyama input. He focuses on the deeply-held feeling that the powers that be (the elites) do not give appropriate respect to particular identities: gender, race, religion, and others. Minorities often are marginalised and dis-respected, and their wish is to be brought into equivalence with majorities, a demand for dignity or maybe beyond. Hence identity politics and what Fukuyama calls the politics of resentment.
There is the other half of that story; that felt by majorities that the identity of the majority is disrespected by the special pleading of the minorities which creates the frustration with political correctness. This is very much the story behind Trump support.
This reads heavily into sustainability. ESG policies are to some just social activism. In the US, libertarian feelings make ESG seem like a political indulgence. Evidence climate change beliefs – a science issue – are heavily correlated with politics – over 80% of Republicans do not believe that the climate is serious risk to our futures. Their belief in personal freedoms, nationalism, market solutions, and light government is a dominant feeling that sees RI as illegitimate.
ESG/sustainability in finance is conflated by feelings trumping reason. We have the US asset owners about three years behind the pace being set in Northern Europe, particularly the Dutch and Swedish.
There is an answer. Action item 4: Beliefs and values process. These are the socialisation opportunities for groups to achieve real change. And it is CalPERS process that is an excellent text book version of how to produce beliefs by coming together, documenting and enacting change with faster process, better decisions and deeper accountabilities; and producing the T-shaped team effort.
10. The leadership examples for us are out there
Asset owners are too important to fail in their mission. They carry a massive burden for the wealth and well-being of billions. They have little choice but to take really seriously their financial stake (remember it amounts to more than $10,000 wealth per adult) and real world responsibilities (much squishier but potentially larger still) and to lead from the front and not to shrink away from the big issues.
Example 1. New Zealand Super Fund
1. Evaluation of climate change as an undue risk which goes against the NZSF mandate.
2. Board engagement in the policy and follow up in the One Planet initiative; what the alignment, ownership and integration intentions actually mean, particularly the energy transition opportunities[viii]
3. Thoughtful index construction to manage carbon intensity. It is clearly possible to use indexes here, very similar to their application to factors, in a sense integrating ESG as part of the risk factors approach.
Example 2. GPIF – the largest asset owner
1. Universal Owner mindset. ‘The inconvenient truth of modern portfolio theory: the more diversified we are, the less exposed to volatility we are but the more vulnerable we are to systematic failure’ (Mizuno)
2. So they pay attention to how the whole portfolio system can be sustainable through ESG and attention to stewardship, particularly in passive portfolios
3. And their ‘doing the right thing’ phrasing which will get more traction over time.
Example 3: OP Trust
What I like is their positivity around their role and their thought leadership, witness this symposium.
Capitalism’s way of working surely must evolve to be more inclusive. I see scenarios in which the investment industry raises its game with more professional, well governed, ethical, organisations playing their part by acting in aligned-to-purpose and efficient ways. The asset owners have the critical role here.
Forces are gathering behind these drivers. The prior blockages including limited data and the restrictions imposed by fiduciary standards are gradually being reduced. In a world of increased stress on climate, resources and societal cohesion, government and governance – asset owners will be pressured into addressing their wider responsibilities.
11. Time for the killer fact
Here is my killer fact. 90% of the population are tying their shoe laces wrong with a weak form of knot, by doing the granny knot with two identical knots. The result: shoe laces come undone.
If the strong form of knot is used, the reef knot equivalent –one ‘left over right tuck under’; one ‘right over left tuck under’ – the one where the knots are integrated then shoe laces would be tied rock solid.
What’s that got to do with this talk? We have the technology to make the changes we need – the shoe laces. But what we need are the human bits – starting with the wisdom, the better integration of the components and the T-shaped know-how.
We also need the courage and leadership, the imagination and vision to make some changes; and critically, the culture to make change stick. For me, the sustainability journey has been gathering pace from 2005 origins. It has been much more interesting and yet difficult than I expected. It has also turned into a mega personal and professional issue – personal because I am passionately concerned that my wife, children and grand-kids face that mother (nature) of all train wrecks; professional because there are things I can and should be doing to contribute in ways that can make a meaningful difference.
And in the words of Fatboy Slim, it starts right here, right now with ‘what I should do on Monday’:
- The asset owner adopting universal ownership purpose
- The 10% T-shaped learning budget
- The scenarios and narratives uplift
- The beliefs and values process
Oh and the shoe laces.
[i] Mark Carney, Bank of England Governor and Chair of the FSB | Tragedy of the Horizon (2015)
[ii] Roger Urwin | The World’s Most Influential Capital (2018) | https://www.top1000funds.com/2018/11/the-worlds-most-influential-capital/
[iii] Kate Raworth | Doughnut Economics (2017)
[iv] WTW Thinking Ahead Institute | Sustainability in investing |Values and Beliefs Project (2016)
[v] William Nordhaus | New York Times The Daily | https://www.nytimes.com/2018/10/19/podcasts/the-daily/climate-change-un-report-carbon-tax.html
[vi] Jonathan Haidt | The Righteous Mind: Why Good People are Divided by Politics and Religion (2013)
[vii] Francis Fukuyama | Identity: The Demand for Dignity and the Politics of Resentment (2018)
[viii] Matt Whineray | Responsible Investor interview on climate and the One Planet initiative (2018)