Editor’s note: This article is the final installment in a four-part series on the rise of sovereign wealth funds and what they mean for U.S. investors.
The New Investor Class
A global trend in the investment world is underway. And this is one that Karl Marx might even approve of.
Some call it “socially responsible investing.” Others use terms like “sustainable development,” “social entrepreneurship” or the “triple bottom line.” Whatever you want to call it, there is growing recognition among a new class of progressive capitalists around the world that investment capital can and sh
ould be used to bring about social change. The motto of the growing movement is “doing good while doing well” and it is not just being adopted by bleeding-heart-social-do-gooders. More and more, professional money managers and pension funds in Europe, Asia and the U.S. are recognizing the link between investment return, profitability and corporate social performance.
Defining what is meant by the term “sustainable” or “responsible” investment is more art than science. Indeed, attempts to reconcile individual conceptions of what it means to invest money in a socially conscious manner is no easy task. Despite the variation in opinion out there as to what it means to invest responsibly (or less socially destructive as the cynic might put it), a common framework has emerged that encompasses four core analytical dimensions. The first dimension, of course, involves the traditional lens of looking at financial or economic performance. The second dimension involves evaluating governance factors which address the rights of shareholders in the context of corporate law. The third and fourth dimensions – social and environmental – are much newer in the lexicon of investment professionals and therefore are far less evolved within mainstream investment circles.
Sovereign wealth funds, like many other institutional investors, are just beginning to establish their investment philosophy as it relates to socially responsible investment criteria. The vast majority of the SWFs currently do not actively integrate SRI factors into their investment management processes (one notable exception is Norway’s Government Pension Fund). Nonetheless, despite the resistance thus far of SWFs to devote serious attention to the second, third and fourth dimensions of the investment equation outlined above (commonly referred by the acronym “ESG”), there is a rising expectation that these institutions can be used to support pan-regional public policy agendas to combat poverty, generate jobs and deliver health care to under-served communities in Asia, Africa, Latin America and the Middle East. The Gulf funds, for example, could play a powerful force in healing long standing religious-based conflicts throughout the Gulf region and beyond by investing in long-term projects focused on education and capacity building. Efforts in this direction would most certainly bolster the reputation and credibility of these institutions among skeptical policy makers in the West.
According to Alessandro Bruno and Afshin Mehrpouya of Innovest Strategic Value Advisors: “By far the most far-reaching aspect of this trend has been its rapid recent growth beyond the narrow socially responsible investment niche into the mainstream investment world.” The authors point out that the recent evidence indicates that “in addition to other less tangible benefits risk-adjusted returns can also be improved by including sustainability factors.” The long-term implication of this thesis, if correct, is that “triple bottom line” investments could reduce the overall investment risk profile of politically volatile regions around the world by increasing the scope of economic opportunities for people living at the margins of society. In so doing, investors in the West could be enticed to put more of their money into developing countries on the promise of safer, yet more socially meaningful, investment opportunities.
There is a pragmatic reason as to why SWFs have not led the charge on this front. State funded institutions are, by and large, passive and long-term investors with little or no desire to influence corporate decisions. This means that they often rely on external money managers in New York and London to cast their proxy votes or make divestment decisions on their behalf. A few do apply ethical guidelines to rule out specific “sin” stocks (like tobacco, military and pornography) that may not conform with the internal objectives and policies of their governments. This is especially true for funds based in Islamic countries whose citizens would most definitely not appreciate using state-owned assets to invest in companies doing business in industries that run afoul of Sharia law.
Among its peers, Norway’s fund has long been recognized as a leader for adopting rigorous internal governance and transparency practices. Now, the fund is setting its sites toward using social monitoring techniques for its portfolio and also appears ready to commit fund assets to help solve the climate change crisis. In August, the Norwegian government hinted that its fund could divert significant monies into a separate fund that will invest directly in clean energy technology. While Norway may still be the exception to the rule at this point, management teams of SWFs around the world are gradually shaking off their reluctance to integrate ESG factors into their investment decisions. Up to now, this reticence has be a function of the sensitivity of managers to avoid any perceived inclination that they are pursuing anything other than a strict financial agenda. As the connection between corporate social performance and corporate financial performance becomes more exhaustively research and validated, there is nothing to suggest that sovereign wealth funds will not also join the swelling ranks of the true believers.
Some funds are at least starting to pay lip service to social and environmental issues. In June, the China Investment Corp. said it intends to be a socially responsible global investor by shunning industries such as gambling, tobacco and arms manufacturing. According to Gao Xiqing, president and chief investment officer of the $200 billion fund: “We are looking at clean energy and environmentally-friendly investment.” According to Mr. Gao, the CIC would look at “everything cross-border except for casinos, tobacco companies or machine-gun companies.”
In light of the simmering political concerns regarding the potential impact of SWFs in international affairs, the overarching goal of integrating responsible investment mandates across borders must be pursued within the broader discussion taking place right now at the IMF and World Bank pertaining to the future role of these institutions in the global economic system. The rhetoric coming from politicians in Europe is a sign that the road to compromise won’t be easy. France and Germany have led the protectionist charge by repeatedly declaring their intention to use government-owned banks to block foreign funds from investing in their economies. According to some observers, protectionist policies, if enacted, may actually harm the ability of SWFs to advance a more progressive investment agenda. The conservative leaning think tank Heritage Foundation cautions: “Erecting barriers to foreign investment would stifle innovation, reduce productivity, undermine economic growth, and cost jobs, all without making America any safer.”
Some commentators have advocated that SWFs should be allowed to invest only in nonvoting equity shares of public companies. The logic here is that this would reduce their ability to actively influence the governance of public companies and eliminate the possibility of foreign takeovers. But this attitude may have unintended consequences. In this context one can see how the debate between passive vs. active ownership becomes an important element in any assessment as to how SWFs will shape their approach in the area of sustainable investing. One concern is that if large SWFs end up adopting a more passive approach with regard to equity investments then these large, dormant positions could undermine the efforts of “active” investors who are trying to engage management around environmental, social and governance issues.
At the moment, top managers at SWFs are acutely aware of how any decisions they make will be construed by the outside world. This, I would argue, is fostering a reluctance to step out of the narrowly defined box they have created for themselves until policy makers in the West become more warm to the idea of foreign funds owning their domestic assets. For the time being, responsible investing – however defined – may be a casualty of the apprehension among these investors to sway too far from their comfort zone.
Yet, it is precisely for this reason that responsible investment mandates must become a major part of the discussion within international financial organizations about how to best regulate SWFs in the future. Let us not forgot that this debate must be more than just about making a sufficient return on investment. For progressive capitalists, it is also about doing good by doing well. It will take time to find a playing field in which all parties in the discussion feel comfortable playing on. For the sake of humanity, I hope they find it soon.
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