Harmonie Club, New York
Good morning. Thank you for the opportunity, etc.
‘The road ahead.’ My thesis today is that leadership is shifting. Mega trends are shaping what we do. Our own role is to provide a vision. Socially responsible investing. Investing. Yes, first let’s remind ourselves that we work with money. Money rules. A government, society, corporations, no entity on the planet comes close to wielding the power of financial services firms. You doubt it? The world’s financial assets (stocks, bonds, bank deposits) are today approximately $140 Trillion but the figure, like markets, varies daily. Add to that global derivatives estimated to stand at $270 Trillion most days. Now consider that the estimated annual global GDP stands at between $61 and $66 Trillion. GDP represents real stuff like jobs and products. The rest just freeloads off the real stuff. But the rest represents about $400 T a day versus the $60-65 T what all nations together are able to produce in a year.
And what are financial services firms doing with this power? Recently Bloomberg Markets magazine ran a feature story that began with the following words: “Hundreds of thousands of workers toil without pay in Latin America, producing timber, gold and the charcoal used to make steel. Their labor goes into materials bought by major companies — including General Motors, Kohler, Toyota and Whirlpool.” The article went on to describe the life of a slave laborer and employers who are, in the words of a Brazilian labor inspector, “willing to defend slavery by force.” Yet we on Wall Street chortle with glee as we review our own cleverness at benefiting from competitive winners. The commitment from a number of the implicated companies — as soon as they received the reporter’s initial call — to suspend purchases from the suspect sources offers no solace. We and they were all eager to take advantage of savvy competitiveness until we were faced with exposure. Financial Services are empowering slave owners.
My mother was fond of teasing us kids when we would fight, she’d put on a serious face and say, “Alright then, first thing we’ll do is we’ll establish the blame.” When I look for someone blame, I find Modern Portfolio Theory; not so much the theory as the interpretation that it dictates fiduciaries behavior. That’s a stretch. It is a theory of managing money, not well being. Modern Portfolio Theory states that a manager ought to construct and maintain a diversified portfolio that has the greatest likelihood of providing the maximum portfolio returns at an appropriate level of expected risk. Fine.
Modern Portfolio Theory is a fine starting point for managing money, but the risk horizon is far too constricted. The real costs of the risks undertaken are not evaluated. Analysis depends on data and corporations have spent the past 50 years perfecting ways to hide data. The 10K must report potential costs from employee harm or environmental damage. We CFAs know that. But it doesn’t. Why? Corporations made accounting rules that state that accounting can only report what is known, so as long as companies fight legitimate claims, the costs are not known nor the threat revealed. So they keep the law suit going for 15 years so they can fail to mention the asbestos liability. They lobby to change the EPA standards as it applies to their special waste rather than admit to the cancer cluster along the shores of Lake Michigan and their potential culpability. The analyst is forced to short term analysis because long term data is hidden. And there are less specific risks as well. Don’t we create risk when we create hatred? Are a million slaves a million potential terrorists? Don’t we create risk when we poison land in our effort to extract minerals? Don’t we create risk when we build houses and bridges as cheaply as possible?
As to reward, focusing on portfolio return rather than on the beneficiary’s well being is okay for a portfolio manager, but in my opinion violates fiduciary standards. ERISA, for instance, guides the fiduciary to look after the financial well being of the person. FINANCIAL well being. Am I financially better off with $14 a month more to retire on if the asthma/cancer/autism/overweight-related heart condition epidemics cost me, through my health care bill, $200 a month? The beneficiary is meant to be the person that depends on the action of the fiduciary a person, not portfolio return.
Large investors ignored all this for a while, but that’s changing. The selfishness and hubris of the CEO pay package is finally beginning to tick off the (relatively) lowly state treasurer. The undermining of American freedoms to protect corporations from the consequences of harming their employees or customers is being challenged by state governments who pick up the tab. Financing the destruction of rainforests is the equivalent of holding a rifle to your grandson’s head and firing. Real fiduciaries know this. The sleeping giant is rising. Leadership in our field is shifting to mega-pools.
Enter the ‘universal’ or ‘permanent’ investor. A large pension plan actually provides for the present and future generations of, say, state employees. The funds involved are so large that broad diversification is a necessity. Domestic, overseas, liquid, illiquid, simple, complicated, all manner of investment, are owned. In other words the fund is betting that the economic engine of the planet will expand, then maybe tweaking the edges. These ‘permanent’ investors, some of whom are speakers today and tomorrow recognize that to a certain extent, their beneficiary is Tom Typical Taxpayer and that what’s good for Tom is the guiding light in assessing their own Duty of Loyalty. This is why you have seen the dramatic growth of institutional shareholder alliances working on our issues.
Consider the Institutional Investors Group on Climate Change. The group was launched in November 2003. Membership has since grown to 50 investors managing nearly $4 trillion of assets. These state and city treasurers and comptrollers, public and labor pension funds, foundations, and others promote improved disclosure of the business risks and opportunities posed by climate change. And as we saw with slavery, disclosure changes behavior. It is a worthy goal. Further, members have invested over $1.2 billion in technologies such as hydrogen fuel cells, ethanol, geothermal facilities and advanced materials and have persuaded several Fortune 500 companies to improve their climate policies. Ah hah, positive investing and activism. Sounds like SRI to me.
Or consider the U.N. Principles for Responsible Investment, whose mission states, “Investors fulfilling their fiduciary (or equivalent) duty therefore need to give appropriate consideration to these [environmental, social and corporate governance] issues, but to date have lacked a framework for doing so.” Its board members include individuals representing New York City Employees Retirement System, British Telecom Pensions, New Zealand Superannuation Fund, Government Pension Fund of Thailand, Government Employees Pension Fund of South Africa and CalPERS, to name a few. These are the classic permanent investors and they are pledged to creating a framework that supports our needs.
And they should be. In late 2005, the United Nations commissioned Freshfields Bruckhaus Deringer, a leading international law firm, to examine whether institutional investors have the right or perhaps even obligation to incorporate social and environmental factors into investing decisions. The study is available at the Freshfields web site. Paul Watchman, primary author of the report, presents the evolving context of modern fiduciary theory and challenges previously understood notions of the institutional fiduciary. His conclusion in every jurisdiction, including the United States, is that what we are here calling socially responsible investing is probably mandated and most certainly encouraged by law.
These three mega-developments are my challenge. My fear is that CalPERS, in its glee to be clean, overlooks public policy. My role, the role of the smaller, earlier wave, must be to needle, wheedle and nudge. Large institutions can think a little too big.
At a certain point we need to drop back to our human selves. My father contracted with farmers in Florida for eggplant crops. He’d buy the crop, peel the eggplant, slice it, dip it in batter, fry it, freeze it and sell it to Campbell Soup or the University of Wisconsin for their Tuesday Eggplant Parmesan offering. When he asked me if I knew of a safe spray to keep bugs off, I shared an apple cider vinegar remedy and asked him why, after all, didn’t the eggplants get peeled? He looked at me in astonishment and replied, “This is food; people eat it.”
Our corporate leaders and many institutional investors have by and large abandoned this straightforward approach to right and wrong. They say they have a right to, that it isn’t against the law, that they already shoulder too many responsibilities that should rightfully lodge in government. And, here’s the damning part, they argue that their investors demand nothing less than ruthlessness. Do you? I’m asking each of you in the room if you intended to poison those pregnant farm workers and blind their unborn babies. Did you intend to give lead paint disguised as toys to children? Did you intend to develop the marshes, the link in the song bird flyway, in such a way as to destroy a species? By your silence you did these things. Ask management at any investment pool, private or public, you work with. They never heard from you that you wanted anything but money.
Ah the road that lies ahead. There will be dozens of issues. What about an anti-terrorist portfolio? What about an anti-poverty portfolio? What about micro-capital? And so forth. Don’t allow the clutter to distract you. Here’s what to focus attention on: the investment world matters, we are creating or destroying the future, we have an absolute duty to do what we can.
Let me ever so briefly remind you of the impacts of the other enormous forces shaping our roadlet, our path. The investment world is global. Social investors in Europe and Asia, growing out of different investment cultures, will continue to challenge our domestic methodologies and our research decisions. They will raise the level of competition in our industry, and the quality of our offerings. They will also force us to live up to the standards of reporting and transparency that they demand, even when these standards are new to us. Those of us who do research envy the Japanese transparency as it applies to environmental impact disclosure and the Danish mandates for public reports from private companies.
Vendors of SRI products in the U.S. will compete against a flood of credible and well-financed offerings from overseas providers. In order to flourish, we must compete on (and effectively communicate) our core values, especially those that differentiate us – not just the thoughtfulness of our investment standards and the depth of our research, but our aggressive form of shareholder activism and our myriad investments in community development. And we must partner with the Swiss, the Dutch and the Japanese to develop a both/and, not an either/or, for the greater goals of our field.
Then there is public policy. With the leadership of key Congressional committees now in Democrats’ hands, many of the values we have fought to keep alive will be of keen interest to legislators. Social investors can play an important role in making corporations accountable for their externalities, clarifying 10-K reporting needs, and increasing legislated disclosures. Disclosure is absolutely essential to insist upon for without it, costs are not counted. Perhaps we can even help ensure that accounting is made to taxpayers, who after all have more at stake than investors in any given company. Taxpayer accounting, almost by definition, will lead companies to begin managing a host of externalities that now go unmanaged, unreported, and largely unmentioned: labor standards, carbon emissions, product safety, and human health and safety.
We have the ability to build a financial services structure that actually supports the creation of universal human dignity and ecological sustainability. Moving mainstream, going global, achieving political influence, and reshaping finance from within — we are ready to emerge as a powerful and important force that changes the world for the better.
Always remember that the people for whose benefit we invest are real people, and that the prize for them is not maximum risk-adjusted portfolio return. They invest so that they can retire in comfort and dignity, in a neighborhood where their grandkids can feel safe, where their neighbors, next door and around the world, can live in peace and freedom.
My grandfather was about 92 when he planted two cherry trees in his front yard. He told me then that they would take about five years to fully bloom and provide the yummy treats that would bring the birds. He spoke with such enthusiasm and I silently wondered, did he realize that he was not likely to see that day? He knew, but it never for a moment occurred to him to deny beauty and pleasure to the world if he could, by his own hand, provide it.
This is our challenge.