Jackie Eberle, Head of Credit, ALUWANI Capital Partners
The world has realised it has been getting things wrong. Economists and investors have realised they’ve been miscalculating risk and returns. More and more pension funds want to understand the social and environmental implications of capital allocations and desire to have a more positive impact with their capital. This is good news, and we welcome a more sustainable approach to investing. We embrace the principles brought about by CRISA, the UNPRI and other initiatives. Indeed, good corporate citizenship is embedded in our company’s values. However, anyone that has tried to implement sustainability has probably realised that this is easier said than done.
One challenge is that of measurement. Management expert Peter Drucker famously said that “You can’t improve what you don’t measure” and this has become a mainstream mantra. The tendency of economics is along the same lines. That is why stay at home parents are assigned very little economic value – their output cannot be measured in a unit of currency, and it is very complex to understand the indirect effect they have on the economy. This example demonstrates that it is easy to ignore something that is difficult to measure in empirical terms. However, it does not mean there is no effect in real life. Our over reliance on measurement (and the overwhelming desire to benchmark) may also explain the climate dominated view of sustainability, while equally important issues receive less attention. Author and investor Jason Voss points out “… benchmarks were supposed to be the foundation for understanding a portfolio manager’s performance after the fact. Instead, the investment industry evolved so that benchmarks are now the navigational compass for investment managers before the fact.”
This brings us to a second challenge. The assumption that impact and ESG variables occur in isolation. One of the first concepts introduced in economics (ergo the field of investing) is the concept of ceteris paribus which is literally translated as “holding other things constant”. This assumes we can change one variable without affecting other variables. Whilst this is a handy shorthand for demonstrating cause and effect, in practice it’s a lot messier. As John Muir (an ecologist) describes “When we try to pick out anything by itself, we find it hitched to everything else in the universe.” An example could be the construction of new infrastructure. This will facilitate economic expansion, create many jobs – worthy positive social outcomes to be sure. However, it is carbon intensive and involves destruction of natural habitat, communities may have been forcibly relocated, etcetera. What did that new highway cost future generations in relation to the benefit to the current generation? Your answer might depend on your perspective. It is a brain-busting exercise to understand the net effect. Often the solution is to isolate one variable to simplify things. That is one route, but we prefer to think of ESG and impact as a non-linear, multidimensional system. In other words, context, relationships, and perspective matter.
Drucker has a point, empirical measurement is important, but it is not the complete picture. We would caution against metrics (benchmarking) becoming an end in and of themselves. Themed investing (such as funds targeting job creation) is useful for providing priorities and direction, but we are wary of oversimplifying. Holistic thinking is difficult and sometimes frustrating, but we believe it is the right approach. After all, isn’t it the primacy of reductionist, decontextualised thinking that got us into this pickle in the first place?