Responsible Investment

Citation

Guyatt, D. and Juravle, C. (2007), "Responsible Investment", Corporate Governance, Vol. 7 No. 3, pp. 326-329. https://doi.org/10.1108/14720700710756599

In the aftermath of the launch of the UN Principles of Responsible Investment, this book is both a timely and informative summary of how practitioners have implemented responsible investment practices. Whilst the scope of this book is predominantly focussed on the UK experience, it usefully draws from perspectives from Europe and the US. The editors note at the outset that the book is intended to be an account of practitioner experience with implementing responsible investment (RI) policies rather than a representation of scholarly work.

The first observation is that the book is extensive in its scope and coverage, with 33 chapters and 36 leading experts. It provides an extensive overview of different agents' perspectives on the development of RI, with good insights into the workings of collaborative initiatives such as the Enhanced Analytics Initiative (EAI) (Chapter 29) and Pharma projects (Chapter 26), the apparent lack of focus on corporate responsibility (CR) in engagement activities (compared with corporate governance (CG)) and some interesting practical examples as to how engagement (Chapter 18) and integration into company valuation processes actually work in practice (Chapters 6 and 9). The book will appeal to those interested in the role and responsibilities of investors in promoting better corporate conduct, as well as students and academics with an interest in this field of study. The chapters of most benefit to RI practitioners are the insights from company executives (Chapters 22, 23 and 24) which provide an honest account of how RI is perceived from the company perspective. This information is valuable not only for practitioners in their ongoing review and improvement to investment processes, but also for academics and researchers in developing a theoretical platform that brings the practice of RI closer to its intended goal.

On the downside, the book fell short of being something that the mainstream investment community might connect with, as it is, by and large, a composition of views from RI industry experts and their agents. Somewhat disappointingly, the voice of the mainstream analyst, fund manager or investment professional that still resist the idea of RI was not heard. Their perspective would have provided a good insight into the intra‐institutional impediments that stand in the way of RI becoming pervasive, such as how the RI team ranks against the mainstream investment teams (internally and in the wider market) in terms of financial expertise, legitimacy and remuneration, and the level of integration in valuation and engagement activities between RI and mainstream investors. From an academic perspective, many of the articles were too short to extract valuable information; it may have been preferable to present less articles but with more detail. Perhaps unsurprisingly given the practical nature of the book, a few of the articles read more like marketing material as the professionals set about describing the merits of the RI process of their representative institution. After scouring the book closely for hints of criticism and introspection within the RI community, we discovered that many lay the blame for the market shortcomings on companies or governments through their lack of effective regulation, but little was said about the behaviour of the investors themselves. The most honest descriptions of the shortcomings with institutional investors are contained within the article by Monks and Sykes (Chapter 20) and those written by “outsiders” such as the NGOs (Chapters 12 and 21) and the corporations themselves (Chapters 22, 23 and 24).

The book begins with some introductory chapters that frame the inquiry, namely whether activism and integration of enhanced analysis into investment decisions could address agency issues, bounded rationality and market failure. The editors hypothesise that active engagement can address all three factors, whilst enhanced analysis cannot address market failure as it is unrealistic to expect analysts to value companies on anything but financial criteria. It is noteworthy that this view is being advocated by professionals within a fund management firm that has chosen the engagement path rather than integration into buy/sell decisions, which makes it all the more important to assess if this view is substantiated by evidence.

On this point, the insightful contributions made by practitioners in Part II provide evidence and case study based examples to illustrate how extra‐financial factors are being integrated into investment decision making. Indeed, such analyses appear to be an important way in which institutional investors could incentivise companies to behave more responsibly. For example, Morley described its scenario based approach where extra‐financial factors are integrated into cash flows and financial valuations (Chapter 6) and Goldman Sachs analysed the oil and gas sector with a view to identifying and pre‐empting risks (Chapter 9); both contributors used a more “mainstream language” with the emphasis of the discussion on investment returns compared to the specialist RI research firms, such as Innovest (Chapter 10) and SAM (Chapter 11) which tend to speak more of company, rather than investment returns. Whilst the industry is still a long way from “extra‐financial” factors being integrated into all sectors of the market, insights from evolutionary convention theory suggest that new norms and conventions are likely to take time to evolve through a process of learning and adaptation (Sugden, 1989 and Choi, 1999) in what is by nature a conservative industry.

Part III includes a series of articles on shareholder activism, with a surprising absence of the leading active fund manager in the UK, Hermes. Many of these articles include descriptions of processes that are readily available on websites; nevertheless some important themes emerged such as the difficulty in evaluating the performance of engagement activities, the lack of engagement on CR issues and the importance of legitimacy of agents in the engagement process. The article by Waygood (Chapter 18) was particularly interesting for its case study based evidence that showed engagement on CR issues can be effective and that collaborative structures are important (in this example collaboration between NGOs and investors), as are power structures, momentum, a willingness to acknowledge and foresee both sides of the debate in working together with companies to promote change in behaviour. All of these factors are worthy of further research by academics and practitioners alike in developing a robust engagement framework.

Part IV contains 13 different perspectives on responsible investment, which in our view is the most insightful and enlightening section of the book. In Chapter 20, Monks and Sykes shift the debate from the problems with agency issues at the company level to the problems within the investment management industry, continuing on the theme of previous writings such as Drucker (1976), Monks (2001) and Ambachtsheer (2007). In particular, they highlight (as does Thamotheram in Chapter 29) the weak incentives that investment institutions face to become more active shareowners and the heterogeneous nature of the community, where corporate pension funds are conflicted due to competitive pressures and fund managers are conflicted due to short‐term relative performance measures.

Monks and Sykes conclude, as do many authors within this book (including the editors), that regulation is required to provide the incentives for change in both corporate and investor behaviour. Whilst scant on detail as to what regulatory measures might be effective, it was suggested on page 239 that trust law needs to be reformed to make clear that an institution acts exclusively for the purpose of maximising beneficiary interests. In concurrence with Tenbrunsel et al. (1997), regulation ought to encourage pro‐active conduct and innovation. This would best be understood as embedding both rewards and penalties for the target agents. Any consideration of regulatory measures would also need to clearly define ownership and trading rights to redress any externalities, such as the EU Emission Trading Scheme (Swanström and Cerin, 2006). Further research on the relative merit of regulatory measures is required, although it is our contention that the potential power of well‐designed collaborative efforts that focus on contractual relationships (such as the EAI) and the mobilisation of intrinsic motivation in creating new conventions should not be underestimated (Schelling, 1960; Lewis, 1969; Sugden, 1986).

The insights obtained from the corporate perspective in Chapters 22, 23 and 24 of Part IV deserve further mention. The authors highlight the need for a unified voice from within the investment management community and a co‐joining of the RI and mainstream teams. They also note that the disparate interests of RI analysts from firm‐to‐firm makes it difficult to know what analysts want; whilst from a marketing perspective it might be appealing for RI firms to have different “factors” that they consider important, this could be holding back the ability of companies to respond to their requests, as well as denting credibility of the sector. Finally, the growth and popularity of questionnaires amongst RI analysts and index constructors has come under criticism from corporate executives as being burdensome and often poorly administered (BAT:250; Severn Trent:256; BT:264). Such criticisms necessitate an assessment of the usefulness of questionnaires from within the RI community Furthermore, research on the uptake and use of indexes (such as the FTSE4Good or the Dow Jones Sustainability Index) by the investment community is needed, including investment agents' attitudes towards these indexes (Marathon Club, 2005), analysis of the size of assets under management that benchmark against such indexes and the extent to which they are used as inputs into the investment decision making process.