The sustainability challenge

The sustainability challenge

In sustainability and Environment, Social and Governance (ESG) we have a subject over-run with confusing terms and a spaghetti soup of acronyms, which have inhibited a much-needed transition. To help simplify this, here is the concept broken down into three parts.  

First, sustainable investing is a natural development of traditional investing. It adds to traditional investing without forgetting the investment principles, that have been developed and practised, when producing the best outcomes in terms of returns given the risks (or risk-adjusted returns).

Second, by adding ESG to the mix of factors we think about to get our returns, we gain much deeper insights as a result, particularly around long-term value creation; and better results should follow. Why? Principally because ESG has a materiality relating to how much value lies in intangible factors, like human capital, which are not captured in a financial statement.

Third, the sustainability concept can go one stage further by considering impacts from our investments on people and planet, and how through positive and deliberate action we can produce positive real-world impacts and also have better investment outcomes as a result. As a pointer here, think how investor pressure on big oil companies has had a positive impact on carbon trajectory and how that’s turning out well for both society and our portfolios. This looks to be a win-win.

Sustainable investing done well should produce better financial and non-financial outcomes. But is there a tension in this win-win scenario, and can we always get both? This is an important question because asset owner investors have to operate within an acceptable space as defined by fiduciary duty.


The fiduciary window
The core concept in fiduciary duty is that asset owners – and the trustees that are responsible for their policies – are bound by a number of obligations to put the interests of beneficiaries first when determining the investment strategy. This fiduciary obligation varies by national jurisdiction and is not black and white anywhere but just about all fiduciary standards have made financial factors dominant.


The fiduciary window is a concept which denotes that a set of investment policies is acceptable from a fiduciary duty perspective, given current interpretations. The fiduciary window is described by two spectra: one stretching from short-term finance to sustainable long-term value creation; and another ranging from pure member financial interest to non-financial considerations and wider stakeholder interest.

This parallels another window, the Overton window, that describes the range of acceptable political views in the mainstream.

Like the Overton window, the fiduciary window is subject to change over time as circumstances evolve. But while the window has been stretched by the influences of a combination of systemic forces that have made sustainability a considerable force there remains a preciousness to retain financial primacy. This makes asset owner trustees keen to follow due process and make sure they have the air-cover for their governance and actions too.

This means that asset owners must adopt well-documented policies that are clearly focused on maximising risk-adjusted returns, and not allow concessions to other motives, such as some parts of the sustainability spectrum, that might diminish risk-adjusted returns. That is, while there may be dual reporting of both financial and non-financial considerations, the primacy of the financial goal is paramount.

So to stretch a well-known metaphor, funds are prevented from trying to kill two birds with one stone, by the principle that aim is taken only at the finance bird.


The 3D investment framework

So how do asset owners try to achieve a dual purpose with one portfolio while not compromising their fiduciary duty? The answer, in our view, is by using new types of investment strategies that can do both – deal with the financial and sustainable aspects – by adding a third dimension (3D) of impact to complement risk and return.

These strategies must include new relationships with asset managers through 3D mandates which comprise 3D goals, longer-term orientation, and a wider base of reporting and accountability. A critical part of this is an increase in active ownership, without which genuine sustainable investment practices will continue to languish. Current active ownership practices are both under-resourced and under-delivering, requiring major improvements in the people model and investment model within investment organisations as well as more system-wide engagement too.


And in implementing a 3D framework – which house these investment strategies – asset owners must be prepared for mind-set challenges that required them to use longer time horizons and more extensive reporting to more interested parties.

The quality and extent of the sustainability transition will depend on the excellence of organisations in several technical dimensions: in 3D frameworks; impact based on innovative research; thought leadership and effective engagement; and particularly in cultural dimensions with purpose and strong fiduciary values coming to the fore.

Where product innovation has been the lead factor in previous transitions, the sustainability transition will likely depend most on the state of organisational culture. We see this not only as the key catalyst to launch sustainability excellence – given its links to purpose, innovation, collaboration and transparency – but also the most logical change lever for leadership to use to achieve this essential transition.

Roger Urwin is co-founder of the Thinking Ahead Institute