Gore's Changes On The Road To Sustainability

Sydney Morning Herald

Saturday November 18, 2006

Simon Hoyle

The climate evangelist is walking the talk on ethical investment. Simon Hoyle reports.

AL GORE has already made the world rethink how it views global warming, and now he wants the investment management world to rethink how it goes about its job.

The former vice-president of the United States, now a poster boy for the burgeoning movement to tackle the climate crisis, is also chairman of Generation Investment Management, which he set up with a business partner, former Goldman Sachs Asset Management CEO David Blood, in April 2004.

"I don't pick stocks, you'll be reassured to know," Gore says. "But in analysing some of these global issues that do have a big impact on the relative performance of different kinds of industries and companies, I have found the conversations with the true investment professionals to be very stimulating, and I think they have too."

Gore was in Perth on Friday addressing the Association of Superannuation Funds of Australia. He says the investment management industry can - and must - make three important changes to address the issues considered to be the cause of the climate crisis.

"First, the full integration of sustainability issues into the evaluation of every investment that's made," he says. "Those factors have often been excluded from consideration in the past, and there are several reasons for that, but the reasons are no longer valid.

"Second, related to the first, is the shifting to a long-term investment horizon, and the re-evaluation of what's called 'short-termism', which has grown to be something of an epidemic in the investment community. And not only the investment community [but] in politics, in the media.

"And third, there should be an evaluation of the compensation practices used to hire managers. I am not implying anything whatsoever to do with ethics at all, it's just the habit that's grown up of compensating managers on a short-term basis, even if they are tasked with long-term management.

"Because if a manager is compensated every three months, or even every year, then the results are going to be optimised for that period of time, because whatever the words are, the money flows towards those metrics. It's human nature."

Gore says GIM avoids the traditional approach of "green" or "ethical" investing, which typically uses "screens" to include or exclude assets from an investment portfolio.

"It's more deeply rooted than that," he says.

A "lengthy and careful study" of techniques used in the past convinced his team that screening does not work.

"I don't want to pick an argument with those who use negative screens, I'm simply observing that it developed into a niche of less than 1 per cent of the market. That's because fiduciaries came to a conclusion that if you do a negative screen, that will, over time, penalise the financial returns. The normal distribution of risks and and opportunities will cover the whole playing board, and if you arbitrarily exclude sectors of it, then mathematically that is likely to produce a penalty ...

"There was a second approach that is also a kind of a screen, a positive screen, also called 'best in class', where these managers said, look, we'll avoid that first mistake. We'll leave everything in play here, but when we get to one of these troublesome areas - tobacco, say, to pick one example - we'll find the most responsible tobacco company, and invest in it.

"But the fiduciary community has also rendered a verdict there, and they've decided - 99 per cent of them, any way - that it doesn't work either.

"So what we did was to start with a clean sheet of paper and build a fully integrated approach. We recruited and built a team that is two-thirds traditional equity analysts and one-third sustainability researchers. The latter group all went back to school to get their Certified Financial Analyst [CFA] ratings, and the team developed for a full year before we even managed any money, a detailed protocol about how to use both of those traditions and sets of experiences simultaneously in a fully integrated process at every step of the investment process."

They found the approach would work best in a long-term framework, Gore says. There is no profit for the first three years, and only then if they have outperformed the market.

"We also manage our own money according to the exact same terms and conditions that we use for our clients. You know the old difference between involved and committed? In a breakfast of bacon and eggs, the chicken was involved but the hog was committed. We're committed to this strategy."

Blood says making sustainability integral to an investment strategy means a manager never finds a company stacks up well financially, but is unattractive from a sustainability viewpoint. If it's not sustainable, it's automatically unattractive financially.

He says Generation defines "sustainability" factors as "the environment, and social - which includes how you operate in your community and how you attract and retain your employees - and other longer-term economic trends, demographic trends and of course corporate governance and culture and ethics".

"These are fundamental factors to determining quality of business and quality of management. The best management teams and businesses actually understand this..."

Gore says investment managers have an obligation to bring a moral dimension to the work they do.

"But that's a loaded question, because the way it's been asked in the past has led to answers that ultimately produced disappointment for the real investment professionals. They have been conditioned to be sceptical about the use of moral judgements in the investment process. That's all quite understandable.

"I think the experience with negative screens and positive screens produced a kind of ingrained resistance to the very notion that there could be a useful way to integrate these factors into the process. And actually, there is. The fact that there is a new way to do it that avoids the mistakes of the past is really important.

"So when you ask the question now, in 2006, does an appreciation of environmental sustainability or the fair treatment of communities where companies are operating, or the ethics of the corporate executives, or the treatment of employees and the families of the employees and whether they can have healthy lives - does that matter to the success of the companies in question and the investment process that looks at choices among those companies? Yes it does - how could it not matter?"

Gore says the result of the integration of sustainability factors into an investment process is that "we add alpha". "Now, we have to continue to prove that over time, and David and I have cultural tension between us, due to our previous lives," he says.

"I'm anxious to tell you how much extra alpha we've added but he's cautioning me that it's too early. Eighteen months could be a statistical artefact. I don't think so. I think it's proof of our skill."

Gore says he and Blood "share a sense of mission to prove the business case and provide to the extent that we can, thought leadership in the industry to encourage others to adopt these best practices".

Blood says a number of superannuation funds in Australia are already "taking the lead on this, and there are a number of investment management-driven initiatives around the world that are promoting the integration of sustainability in the investment process, including the Principles of Responsible Investing, which is sponsored by the United Nations".

"I think there's now something like $US6 trillion [$7.8 trillion] worth of signers, including a number of Australian institutions," Blood says. "There's the Enhanced Analytics Initiative, which UniSuper here was the first Australian to sign. The overlaps between the two initiatives are quite significant, incidentally.

"And there are other, broader initiatives that are highlighting and identifying sustainability as important factors. So there are asset managers, asset owners, here in Australia - in fact we think Australia is ahead of the United States, for example, in understanding the importance of these issues. There are a number of business leaders and investment managers who are very clearly in the lead on this subject.

"I think it's going to be important that more of the asset owners embrace this; that those who have superannuation encourage their managers to do that is a good idea, [and if] other asset owners ... ask asset managers to make sure they're considering these factors [it] will be helpful."

© 2006 Sydney Morning Herald

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