Burgess COMMENTARY
Thanks ... a good essay, but essentially a rather sad story. Yes ... 'we have messed up the capitalist system for decades' ... but when is this idea going to be embraced by the big players that dominate investment decisions. I like the 'shout out' for SASB, GRI and IIRC but the link between Responsible Investing / ESG performance / etc and company performance is tentative at best. When company and return to investors is the dominant component of decision making, people and the environment are going to be left as failing components of the system. Erika Karp is on the right track ... but most of the investment community is still out of touch with social and environmental realities. Peter Burgess ... http://truevaluemetrics.org
Peter Burgess

The Evolution of ESG: An Interview with Erika Karp

As a financial tool, environmental, social, and governance (ESG) analysis is evolving rapidly. Awareness that it is more than just a “feel-good” term is growing, as is the knowledge that it is useful for both risk management and return enhancement.

Unfortunately, there is still much confusion in this emerging field of analysis. Many of the larger institutions have been slow to fully embrace responsible investing, while more recent players are setting new standards for evaluation.

To understand the current state of sustainable investing, I spoke to Erika Karp, keynote speaker at the recent RIA (Responsible Investing Association) Canada conference in Toronto. Karp is the founder of Cornerstone Capital Group, an investment advisory focused on sustainable investing and finance. She is a founding board member of the Sustainability Accounting Standards Board (SASB), a member of the World Economic Forum’s council on financing and capital, an advisor to the Clinton Global Initiative, and was previously head of global sector research at UBS.

What follows is a lightly edited transcript of our conversation.

Anjali Pradhan, CFA: Why did you start your own firm? What opportunity or need did you see in the market?

Erika Karp: I like [this line] about entrepreneurship, “In order to get going, you simply need to know that you are not staying where you are.” You don’t have to know everything, but you do need to know that staying in place won’t work. That is speaking to my lack of tolerance for the status quo when it is not serving the needs of the market. With this in mind, I came up with a business model that is unique, scalable, and built to address powerful demand.

When you are in a large institution trying to drive change, sometimes you can’t move as quickly as you would like given the market opportunity and the imperatives. I tried as hard as I could to change a large institution from a pretty high level, but sometimes you need to be faster. I saw a compelling opportunity — a vacuum in the market for a service proposition and decided to act on it. Bigger banks are slow to change their business models. In order to have impact at scale, business model innovation is essential. Sometimes one has to be disruptive from the outside.

Entrepreneurship is like jumping out of a plane and building a parachute on the way down. It can be very scary, very volatile. Sometimes I go from feeling a soaring sense of wonder to experiencing abject panic in the same day. The journey is very exciting.

Why do you think sustainability should be a key component of financial analysis? Why should corporate sustainability equal corporate excellence?

I would argue that an analyst, portfolio manager, or a chief investment officer who doesn’t consciously and systematically look at material ESG factors in investment decisions [is] breaking their fiduciary duty of care and should even be fired. It’s a matter of more systematic analysis of long-term risks and opportunities.

To perform robust financial analysis, you have to look at factors that are material to the economic and profit outcomes. You cannot tell me that some of these ESG factors are not material (albeit sometimes industry specific). I’m happy to go with [a paraphrase of] the US Supreme Court’s definition of materiality: “What piece of data in a mosaic would have made an impact on your investment decision had you known it?” It is a [form of the] “reasonable” investor’s standard. I’ve been in the business for a while, I consider myself to be a “reasonable” investor. We consider critical issues by sector around ESG. Whether they are issues related to safety or resource utilization, these are absolutely critical to the economic outcome in the long run.

In the short term, it might be pragmatic to completely exploit all the resources at your disposal. If that’s the case, it should be stated as your plan. Then we can attribute little intangible value to your enterprise. I’d short ignorance.

What we need to do is think long term. We’re not going to tell asset managers what to do, but we are going to ask them to disclose what they do and how they do it. Then we monitor the situation to hold them accountable if they do not execute, or they drift from their stated practices.

There is little standardization in ESG in terms of language and data, and this leads to confusion. How can we remedy this?

Standards for disclosure around material ESG factors by sector are critical. Once we have this, we can start to innovate at a faster rate. That’s a piece of infrastructure that’s been missing. Thanks to SASB, the Global Reporting Initiative (GRI), and the International Integrated Reporting Council (IIRC), we are starting to get standards. Then we can get comparability and the ability to project with higher quality data.

Indexes based on bad data are frightening to me because they undermine the economic outcomes we are trying to attain. I am worried about the quality of the products currently being built around questionable facts and figures. We shouldn’t multiply systemic errors, which we as an industry may be doing.

Your website mentions: “Our values are based on transparency, open architecture, diversity and collaboration.” How did we get to a place where these ideas in finance are revolutionary and what can we do to improve upon this?

We’ve messed up the capitalist system for decades. Incentives have been distorted, and that has driven behaviors that are short-term oriented. In the financial services, there are a lot people with vested interests, people with self-serving agendas, and those who operate in silos. It has worked well for some. There are others who are protecting the status quo. With regard to embracing the discipline of ESG analysis, I think all the excuses are off the table. We have to be ready for change. While there is a very steep learning curve in the world of sustainable impact and finance, it shouldn’t be revolutionary. It should be blindingly obvious that we need collaboration, transparency, communication, and aligned incentive structures.

Long-termism versus short-termism comes down to incentive structures. The issue will end up being dealt with analyst by analyst, firm by firm. Frankly, short-termism has done so much damage that we’re seeing incentive structures evolve both in the corporate world and in the investment world. This will allow more thoughtful outcomes in terms of the deployment of capital — financial, natural and human/relational.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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