February 1, 2019

Is The Move To ESG Investing Fake Or Real? How Asset Owners Should Address This Question

“With the rising awareness around ESG issues, institutional investors have started to massively look into responsible investing…..”

Investment & Pensions EuropeJanuary 2019

Fake or Real?

If you believe what you read in the media, a ‘massive’ shift to ESG investing is taking place. This shift to focusing on environmental, social, and governance factors promises to enhance investment returns while making the world a better place at the same time. Is this true or fake news? Last month’s Letter proposed a simple test to answer this important question. It is to carefully study how asset owners tell their value-creating stories to their stakeholders. Unless these stories are clearly credible, the ‘massive move to ESG investing’ becomes just another case of investment industry hype triumphing over reality.

Last month’s Letter also explained why we should focus on the behavior of asset owners. Regardless of whether they are pension, endowment, or sovereign wealth funds, asset owners have a fiduciary duty to create value for their stakeholders. Collectively, they sit on top of the financial food-chain, and where they go others follow.  And how to assess if their value-creating stories are credible? The Letter’s answer was: by using the Integrated Reporting (<IR>) Framework promulgated by the International Integrated Reporting Council (IIRC) in December of 2013. While the original Framework context was value-creation in the corporate sector, the Letter showed it is an equally powerful guide in the asset owner sector.

Why is the <IR> Framework so powerful? Because it requires asset owners to clearly explain why they exist and what ‘value creation’ means for them and their stakeholders. It further requires them to:

  • Explain how their governance structure and processes contribute to the organization’s efforts to create that value.
  • Explain the business model that is to create stakeholder value, and the use of the six ‘capitals’ at their disposal (financial, manufactured, human, intellectual, social, natural) to get the job done.
  • Explain the risks and opportunities that must be addressed.
  • Report the actual value-creation results that have been achieved, focusing especially on longer timeframes.  
  • Explain the strategies and resource allocations that will be employed to create value in the years ahead, and the associated challenges that will entail. Think this through not only at a micro within-organization level, but also as a macro across-organizations level (i.e., how asset owner decisions collectively impact the financial markets, social conditions, and the environment).

Through this <IR> lens, it will quickly become clear if an asset owner organization is serious about creating stakeholder value, or whether it is faking it. For example, have the action implications of ESG really been integrated into the asset owner’s governance structure and processes, its business model, and how it describes its risks and opportunities? If that is the case, its reporting would include clear explanations of how the organization assures its own ongoing board effectiveness, how ESG dimensions are integrated into its business model and risk/opportunity assessments, how it assures its human and intellectual capital are fit for purpose, how compensation structures are aligned with intended outcomes, and how its micro decisions aggregate with those of other asset owners to impact (positively or negatively) social and environmental conditions worldwide.    

Initial Responses to the <IR> Adoption Proposal

Can asset owner organizations be persuaded to actually adopt the <IR> Framework in how they tell their value-creating stories? Early responses to my <IR> proposal from CEO/CIO/CFOs of leading asset owners are promising. Here are seven:

  • “I’ve asked my staff to look into the <IR> Framework….I want to learn more about it”
  • ”A nice reporting framework for asset owners….and for asset managers too…”
  • “Great idea, the concepts of integration and story-telling are super important to us…”
  • “We would be forced to address our strategic challenges if we adopted the <IR> Framework….”
  • “Use of the <IR> Framework would create greater asset owner comparability across organizations and across time….”
  • “The <IR> initiative is sound and asset owners need to lead if we are going to hold our investee corporations to this standard….”
  • “I am on board to implement what you propose….but will need to bring my colleagues with me…”

There are two clear messages here. The first is one of genuine interest in using the <IR> Framework to tell the value-creating stories of asset owners to their stakeholders. The second is a requirement to move beyond this general positive reaction to a more granular understanding of what such a move actually entails in practice. This Letter begins to address this second requirement, focusing specifically on the  asset owner ‘value-creation’ question and the dimensions of the business model required to produce the desired value-creating outcomes.  

Addressing the ‘Value-Creation’ Question

The <IR> Framework forces asset owners to address an existential question: why do we exist? A too simple answer is ‘to manage the asset pool so that it achieves its intended purpose in a cost-effective manner’. That statement should prompt two further questions: 1. What is that intended purpose? and 2. How to define and measure cost-effectiveness? The two answers set the ‘value-creation’ narrative off in two directions: 1. A description of the future payment obligations the assets are intended to meet, and 2. A description of  the meaning of ‘cost effectiveness’ in the context of the strategies used of the achieve the assets’ intended purpose, and how that meaning could be measured in practice.i      

But even with these answers, the job is not done. Asset pools with payment obligations to many people over long horizons require that the fairness question be addressed: how to ensure that some groups of people are not systematically disadvantaged to the benefit of other groups which are systematically advantaged? What mechanisms have been put in place to prevent this from happening? And even that is not the end of the fairness question. It needs to be posed in two contexts: 1. In relation to the current and future direct beneficiaries of the asset pool (e.g., pension plan members or sovereign wealth/endowment fund beneficiaries), and 2. Also in relation to current and future members of the human community at large. Why? Because if current asset returns are generated at the expense of deteriorating future social and environmental conditions, then future members of the global community are unfairly disadvantaged.    

The point of this discourse is to show that ‘value-creation’ needs to be subjected to the Einstein test of ‘making things as simple as possible, but no simpler’. Overcoming the temptation to over-simplify ‘value-creation’ requires strong doses of integrative thinking and courage.ii

The Requisite ‘Business Model’

What kind of conceptual structures, modeling capabilities, and people does an asset owner organization need to assemble to produce the kind of micro and macro value described above? Collectively, these organizational ‘capitals’ must be capable of doing three things:

  1. Assess Asset Adequacy: the ‘business model’ must be able to assess if accrued assets are sufficient to meet future payment obligations, or conversely, assess if the current payout formula to members/beneficiaries is sustainable over the long term. It must also be able to assess if one or more groups of beneficiaries are being systematically disadvantaged to the benefit of other groups. Unsatisfactory answers should trigger actions to explain and rectify the problem.iii  
  2. Assess Risk Appetite and Set Consistent Risk Exposures: the ‘business model’ must be capable of matching broad asset risk exposures over relevant time horizons to the ability and willingness of asset stakeholders to bear it.iv Key aspects of this capability are pension and  endowment plan design defaults and stakeholder communications structured to be consistent with behavioral economics research.v
  3. Define Investments Beliefs and Acquire Requisite Implementation Capabilities: part of ‘business model’ design is deciding to (or not to) create (or hire) the capability to identify distinct investment opportunities that generate higher long-term sustainable risk-adjusted rates of return than their passive alternatives.vi This should be stated as an investment belief into which ESG factors are integrated. Two related key organization model questions are the mix of insourcing versus outsourcing, and the mix of public versus private markets exposures.vii Also, model capability is required to assess the macro impacts of the asset owner’s chosen  investment program. Integration aids to do this systematically include the 6 PRI stewardship obligations and the 17 UN Social Development Goals.viii    

The January 2019 Letter listed seven <IR> content topics, of which two are examined in some detail above and in the Endnotes (i.e., organizational purpose/value-creation and business model). Other <IR> content topics (e.g., governance, performance measurement, risks and opportunities) will be addressed in greater detail in future Letters. We close this Letter with some thoughts on the <IR> topics of strategy and outlook, and how the ESG phenomenon relates to all this.

Strategy, Outlook, and the ESG Phenomenon

<IR> forces the integration of organization purpose, governance, business model, and the considerations of risks and opportunities into a coherent forward-looking organizational outlook and strategy. Specifically, what does the organization intend to accomplish in value-creation space in the years/decades ahead, and what does that imply for the availability and use of the capitals at its disposal?

All this takes us back to the question the Letter started with: is the ‘massive’ move to ESG investing taking place fake or real? Organizational stories using the <IR> Framework will tell the tale. Only stories that see ESG as a means to an end rather than an end unto itself are credible. In <IR> the end is always organizational micro and macro value-creation, and the informed, intelligent use of ESG factors is only one of a number of means to that end.

Keith Ambachtsheer         



  1. See our November 2014 Letter for more on this.
  2. See Howitt, Thurm (2018) “From Monocapitalism to Multicapitalism: 21st Century System Value-Creation”, Thomson Reuters, for an expansion of these ideas.
  3. See our December 2018 Letter for a deeper analysis of the unfairness issue.
  4. See our September 2018 Letter for more on this. There is also the related question of life-cycle-related risk-tolerance differences between young and old members of collective pension plans. The key risk for young members is insufficient multi-decade return compounding, the key risk for old members is pension payment uncertainty. The simplest design solution here is for the pension plan to have separate return-seeking and payment safety-seeking investment pools and to have plan members transition from the return pool to the safety pool on an age-related basis.
  5. See our October 2018 Letter for more on the insights of behavioral economics on designing retirement savings arrangements and communicating with retirement savers.
  6. This of course is complex topic which has been widely debated starting in the 1930s by John Maynard Keynes and Benjamin Graham. The Efficient Markets Hypothesis developed in the 1960s and 70s set out an alternative point of view. Andrew Lo contributed to the evolution of views on market efficiency with his Adaptive Market Hypothesis, as did Mordecai Kurz with his Rational Beliefs Hypothesis. Our Letters have been addressing active management issues since 1985, most recently in the July 2018 Letter. A new study by Harvard University Professor George Serafeim titled “Public Sentiment and the Price of Corporate Sustainability” shows that commercial ESG/Sustainability rankings are increasingly reflected in stock prices, unless overshadowed by negative short term market sentiment. An implication of Serafeim’s findings is that to be useful, equity valuation models need to be regularly updated to reflect changing investor beliefs and behaviour.
  7. See our August 2017 Letter for a detailed exposition of these issues. The heart of the ‘internal vs external’ matter is for the asset owner organization to have the mandate, scale and governance capacity to insource the investment function. Research confirms that insourcing under these conditions is a value-creating decision. This is especially the case when significant private markets activity is contemplated.
  8. For example, in relation to the PRI principles, asset owners can explain how ESG issues are incorporated into their investment processes, how they are active owners, how they seek and provide appropriate <IR>-based disclosure, and how they work with others to achieve these ends. Monitoring macro impacts also requires access to new metrics and new databases, for example, screening investments against the requirements of the UN Global Compact and on ESG performance.


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