Balancing the long-, middle- and near-term risks to set a sustainable course

Balancing the risks to set a sustainable course

Leaders see benefits in aligning corporate and social values due to environmental trends

Partner and Global Head of Investment Management

KPMG in the UK

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Recognizing that traditional models and short-term thinking are no longer an adequate response to rising global volatility and complexity, investment industry leaders are accepting that it’s time to prioritize sustainable business strategies that tangibly balance financial, social and environmental goals.

The challenge lies in learning to shift from short- to longer-term thinking – often in the absence of reliable long-, middle- and near-term data – so that investment managers can take present day actions that support a sustainable, long-term course.

The road to acceptance

Many corporate leaders are now acknowledging the need to align corporate and social values as a result of pressing externalities – like resource insecurity, mounting environment risks, the growth in socially responsible behavior and regulatory pressure – which are suddenly impacting their revenues, costs and risk. These urgent environmental trends  and changing social values, when combined with parallel demographic, and technology megatrends, are forcing the investment sector to examine how their business must change over the next decade, and what steps they should take today. 

For investment managers, the recent global economic crisis was a catalyst. They realized that, although the world is typically awash in volatility, uncertainty, complexity and ambiguity, many of the foundations of our financial system were created between the 1950s and 1970s, a period of abnormal stability. That era shaped our current ‘financial markets orthodoxy,’ including beliefs about everything from debt equity ratios and acceptable rates of return to incentive structures that reward short-term performance.

These market principles began to prove problematic in the 1970s, but the unprecedented 2008 financial crisis dramatically revealed the need to rethink how corporate value is measured. investment managers began to question the prevailing emphasis on short-term value creation, which actually worsens volatility and conflicts with longer-term growth objectives. 

Pioneers in sustainable investment

We now see a breed of investment managers who are challenging traditional strategies with alternative investments. Typically these firms operate within close proximity to management decision-making within their portfolio holdings. For example, private equity investors have greater ability than public markets investors to understand and influence the companies they invest in. These firms are now encouraging their investee companies to focus on long-term growth strategies to create both shareholder and societal value. 

Similarly, pension funds are focusing on longer-term value creation, due to their mandates to satisfy the interests of future beneficiaries. They are increasingly focusing on private equity, real estate and infrastructure assets to support a longer-term vision.

Other funds are extending their fiduciary duty to honor investment practices that serve both current and future beneficiaries. They can then adopt investment beliefs geared to creating long-term sustainable value or engrain environmental, social and governance (ESG) factors in their asset management strategies. Such actions are attracting attention, particularly when funds with ESG-linked mandates actually outperform the benchmarks.

First steps to sustainability

KPMG’s recent report on sustainability,  A New Vision of Value (PDF 5.48MB), highlights five key interventions among those front-running investment firms that embrace sustainability:

  1. Demonstrate investor leadership and action, by encouraging businesses and policy-makers to support longer-term business strategies that incorporate social and environmental stewardship.
  2. Clarify fiduciary duty, so that investment decisions are made in the best interests of current and future beneficiaries.
  3. Understand the relationship between corporate and societal value creation, by building the skills and processes to understand and evaluate the materiality of ESG issues and the impact on performance.
  4. Change mandates and incentives, to drive fund manager behavior to pursue long-term value creation.
  5. Improve the quality of data, by establishing new metrics that quantify societal value creation, balance short and long-term performance objectives and demand accurate reporting. 

Broadly speaking, these interventions require investment managers to establish a vision and then review and refine their internal governance structures, perhaps with the aid of a senior leader responsible for the sustainability strategy and empowered to guide investment practices.

These firms must also build an organizational culture that can perform well in ambiguous environments. They must learn to manage in the absence of clear data, mitigate the risks, and enable fund managers to move from short- to long-term thinking.

You could compare this delicate balance to the driver training provided to police officers who must pilot their patrol cars through risk-filled, crowded streets. Officers are taught to scan – in this order – the far horizon, middle distance, the space in front of their car, and repeat. By monitoring oncoming hazards in this way, police drivers can make effective, immediate course corrections to reach distant, strategic targets. This same approach could help investment managers shift from near-term thinking to a wider view of business which considers the implications of the social value and environment megatrends enabling sustainable present day decisions. 

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