Attaching accurate values to E and S: why I joined Schroders

“With great power comes great responsibility”, according to Spiderman.

This applies to the real world of pension funds. With their trillions in assets, they have the means to drive massive shifts in capital. They can set entire industries on pathways to more sustainable business models. But do they have the mandate and appetite to do so?

All too often, the goal is to be compliant and “do some ESG”. But those are sanitation factors, not the end goal.

At the Dutch pension funds I talk to, they know this. For them, the goalposts have already shifted. They want to achieve good investment returns in an economy operating within social and planetary boundaries. Or, to put it differently, they adopt a dual return perspective: they want both good financial results and good results for society and nature.

This is consistent with what I want as a beneficiary: not only a decent pension for myself, but investments managed in such a way that by the last quarter of this century, my children too will receive a decent pension in a fair and inhabitable environment.

The challenge for these pension funds is to build an investment framework around achieving this dual return. It needs to include measurement and reporting to show that these goals are actually being achieved. Many recognise that delivering social and environmental benefits is not only consistent with long-term return goals, but a pre-requisite for delivering them. 

These frameworks are typically not yet in place. It’s becoming increasingly clear that ratings and labels are insufficient in achieving and measuring dual returns. This is reflected in conversations with pension funds, and the language they use. Some are no longer asking for “ESG” or “sustainable" investments, but for “portfolios of companies that make the world a better place” (pension fund x), “impact as a third dimension” (pension fund y) or “long-term value creation” (pension fund z).

While pension funds x, y and z use different terms, their requests have a lot in common. They want well-diversified portfolios of companies that create value in financial, social and ecological terms. They want intense engagement and long holding periods. They want concentrated portfolios so as to 1) make engagement pay off, and 2) to know every company in the portfolio and how it makes a positive contribution. And they want to communicate all the above to their constituents in a clear and credible way.

That is not a trivial task. Of course, strong asset managers know how to build concentrated portfolios and they can offer intense engagement and long holding periods. But the differentiating factor is the rigorous measurement of value in environmental (E) and social (S) terms. In that way, it can be shown that these companies do make the world better, and by how much. And further, the valuation of E and S informs engagement and investment decisions. One can then truly take a dual return perspective.

The importance of considering E and S in value terms can hardly be stressed enough. And it typically takes people time to internalise this thinking. It is probably the most important point that Prof Dirk Schoenmaker and I make in our textbook “Principles of Sustainable Finance” – and it was a key factor in my decision to join Schroders.

Over the years, Andy Howard and his team have built a unique and impressive data machine with a suite of proprietary tools. Of course, other asset managers have proprietary tools, but Schroders alone to my knowledge has a tool like SustainEx, which does exactly what we propose in our book: expressing sustainability issues in value terms, or, put differently, valuing companies’ externalities.

The challenge now is to put that machine to optimal use. For me, personally, it was great being an independent sustainable finance adviser, and helping a select set of clients. But it is even better to do so with the backing of the Schroders platform, with its unique capabilities that match the vision of our book.

It will help take the dialogue with clients to a higher level, allowing them to achieve investment returns in a wide sense. Not just financial results, but strong social and ecological outcomes. That is what the value-add of asset managers will increasingly be: to deliver not just alpha, but alpha plus long-term value, or whatever you want to call  it.

Of course, this raises further questions on topics such as fiduciary duty, the nature of long-term value, and the relation between sustainability and risk-return.

I look forward to exploring some of these difficult questions and more in my new role.