Sustainable Investing Practice: Simplified Complexity

Abstract

The model of “sustainable investing” presented in this paper is of long-term investing that is inter-generationally efficient. This model combines the opportunities in the traditional areas of institutional decisions – asset allocation and manager line-up – with the newer fields of extra-financial factors including ESG (environment, social and governance) and active ownership. The development of this model relies heavily on complexity theory in which a system has the properties of: being dynamic and often away from equilibrium; is characterised by agent behaviours; behaves interactively including network effects; produces the emergence of macro patterns from micro-level behaviours; and evolves its characteristics from survival and growth factors.

We conclude there are significant investment opportunities for those that focus their attention on “sustainable investing” which can be seen to comprise three broad areas: the asset allocation and manager areas where large costs are incurred as a result of poor sustainability practices; the ESG area when an integrated approach is desirable; and the sustainability mandates area where more sophisticated beliefs are necessary. We see a particular opportunity for sustainable mandates. These will require asset allocation disciplines and we put forward a process for determining appropriate figures in this regard. We include a process by which funds that have dual missions can make such an allocation.

We see retirement and economic sustainability as critically positioned at tipping points in their development; developed world aging and shrinking workforce are leading to big increases in the dependency ratio – raising issues about sustainable retirement; while at the same time population growth and development are challenging the carrying capacity limits of the planet – raising issues about sustainable development. Sustainable investing provides a link between these two issues and presents a win-win: more sustainable investing returns produce both better retirement outcomes and environmental outcomes. Institutional investment funds need to raise their game and play a part in these challenges by employing integrated and/or targeted sustainable investing. Those funds will be able to do so only if they strengthen their governance.

Keywords: Pension Fund, Sovereign Wealth Fund, Sustainable Investing, Sustainability Mandates, Investment Strategy, Investment Beliefs, Asset Allocation, Governance, ESG, Complexity