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Are low yields and volatility killing responsible capitalism?

Hermes Investment Management, the £26 billion manager focused on delivering superior, sustainable, risk adjusted returns to its clients – responsibly, has today published the first paper from its annual Responsible Capitalism survey[1], Many rivers to cross – Slow progress towards responsible capitalism.

The survey reveals a number of emerging trends that have worrying consequences for responsible capitalism advocates. The survey of 102 leading UK & European institutional investors found that 7% fewer investors believe significant environmental, social and governance (ESG) risks justify rejecting an otherwise attractive investment than a year ago. This is despite an annual 10% increase of investors (56.4%) believing companies that focus on ESG issues produce better long-term returns.

Furthermore, when asked if organisations that adhere to strong ESG principles are less susceptible to market volatility, a total of 80.2% of those surveyed responded ‘no’ or ‘don’t know’ (59.3%/20.9%). There was also a 1.8% increase from last year in those surveyed who believed managers should not price in corporate governance risks as a core part of their investment analysis, alongside traditional financial metrics.

Saker Nusseibeh, Chief Executive, Hermes Investment Management believes the current lack of yield and increased volatility may have pushed increasingly under-pressure investors to turn their back on responsible capitalism.

Nusseibeh said: “Dwindling income streams and escalating volatility may have caused an increasing amount of normally ethically-minded investors to eschew principles of responsible investing and adopt an investment strategy based on short-termism.

“What we are seeing are hard-wired psychological responses to meeting volatility event by event, and a relentless focus on short-term financial outcomes. Investors are not only failing to recognise the long-term and profound implications of their decision making, but also that ESG considerations are still very much compartmentalised rather than being included in core economic-based decisions.

“We believe this to be fundamentally wrong, not least because a truly long-term view, i.e. investing with conviction in good companies and assets, gives a compass with which to navigate choppy market waters.”

Maximising pension returns still trumps improving society

The survey revealed that 44.6% of those surveyed believe pension funds should not give greater consideration to whether their current investments will improve or detract from the overall quality of life experienced by beneficiaries when they retire, and instead focus exclusively on maximising retirement incomes. Of the remaining respondents, 41.3% percent of investors disagreed, while 14.1% did not know.

However, when asked, given the fiduciary duty of pension funds to maximise retirement incomes for beneficiaries, 60% of institutional investors felt that significant ESG risks with financial implications justified rejecting an otherwise attractive investment.

Nusseibeh continued: “While things are moving in the right direction (4.3% more respondents agreed that investors should give increased consideration to quality of life than last year), global capital is still not managed in a way that takes responsibility for shaping society seriously.”

Short-termism prevails but there are positive broader trends

While the survey shows a trend towards short-termism, there are broader, more positive shifts embracing ESG concerns and responsible capitalism. In fact, 73.1% of respondents expect to see more investment opportunities rejected by pension schemes due to ESG risks, while only 1.1% expect the number to decrease.

The survey also suggested investors are thinking about the impact of their investee companies, as 55.4% consider ESG monitoring and reporting of supply chain to be either ‘vitally’ or ‘ very’ important.

“Investors are increasingly aware of the importance of seeing companies in the context of their stakeholder relationships. However we are still waiting to see the gradual shift in mind-sets reflected in portfolios,” stated Nusseibeh.

Investors to shun companies engaging in strategic tax avoidance

In what is becoming an increasingly global issue, 47.7% of respondents believed institutional investors would not continue to invest in companies that have been in public focus for the strategic avoidance of corporate tax, regardless of financial returns.

On the issue of transparency, 61.8% of respondents believed fund managers should be more transparent and share their ESG analysis of companies with clients on at least a quarterly basis.

Nusseibeh, said: “The evidence from the survey shows that while investors are beginning to feel uncomfortable about companies that behave poorly – such as the big polluters or those avoiding paying their share of taxes to support the future development of societies – it is taking a long time for those companies to be excluded from portfolios.

“The investment community fails to accurately account for the effect of those factors on the value of economic activity and, by extension, future returns. The result is a yawning gap between what savers want and what the investment community can deliver. There is clearly some way to go in convincing investors to think about retirement outcomes in broader terms than maximising retirement incomes.”

How capitalism can shape a better future

Nusseibeh said: “Ultimately, investors must reject the emerging short-termism revealed and consider how we can better harness capital to shape a better future. The separation of investment returns and outcomes happens because investors have learnt over many generations to look at value in two-dimensional terms: risk and time, which sit at the heart of all discounting methods and asset pricing models used in finance today. When investors are calculating expected future returns of investment, a positive or negative external impact on society is therefore treated as an addendum.

“This view cannot prevail in the long-term. The decisions we make as asset owners and asset managers are the single most powerful force in shaping the society of tomorrow. Very little in the world can happen without the allocation of capital – we can decide to invest in new technologies or hold companies to account for their behaviour. We as investors must understand that capital is the greatest weapon in the fight to shape the future.”

[1] Survey conducted by Citigate Dewe Rogerson

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