Institutional investors can shape the future of capitalism

October 12, 2012 | 3 min read

Once, around 6000 BC, a camel was the fastest means of transportation at a speed of about eight miles an hour. Today we can travel by plane as a common means of transport with speeds of well over 500 miles an hour. And our world is changing at an equally rapid pace. Nations, companies and institutional investors alike are set to lose their relevance if they fail to adapt in this world of ever-increasing change. Tomorrow’s world is becoming less and less predictable as a result of the rapid pace of change. Denying uncertainty or resisting change could harm businesses and whole industries. Institutional investors, especially pension funds that operate with an investment horizon of multiple years or even decades, and whose long-term liability duration therefore dictates long-term orientation, are similarly affected by this mega trend.

Information is increasingly being disseminated, shared and accessed around the globe and becoming ever richer in content. From year One AD it took fifteen centuries to double the world’s accumulated knowledge, while it had doubled again only two and a half centuries later. Today, the doubling speed stands at one to two years! While arguably not all information is material, it is already a mindboggling task to separate information out into what is material to institutional investors and what is not. The fiduciary duty of pension funds in particular means that they carry a huge responsibility in deciding what is material information and what is not.

Shifting balance of power

Globalization is shifting the balance of power between companies, nations and consumer groups and making our world more interconnected and interdependent than ever. It has generated sustained economic growth for a generation and shrunk and reshaped the world at the same time. Newly emerged players such as consumer groups, NGOs and large global companies are having a strong influence on the competitive landscape, opinion building and inducing shifts in perception and behavior, as illustrated by the Facebook community with over 950 million users, half of which on a daily basis.

The fact that the Earth’s carrying capacity is being exceeded at an ever faster pace is without doubt material to companies, nations, investors and consumers. Climate change, pollution and scarcity of resources all relate to our present exceedance of the Earth’s carrying capacity. McKinsey/IFC investigated global water availability on a catchment level and predicted a supply gap of 40% until 2030 in a business-as-usual scenario. Where supply is not able to keep up with demand, extreme volatility and a sustained increase in the price of energy, food, water and commodities are the result.

Shifting demographics and consumer behavior form a fifth trend. Changing consumer demographics impact spending patterns, as more mature customers have a greater disposable income. At the same time consumer expectations are increasing while their tastes and preferences change at a dizzying pace. For instance, changed habits of the surging Chinese middle class led to total annual growth rates of 28% for baby food sales over recent years and 3.7% annual growth in per-capita meat consumption.

Corporates are ahead of institutional investors

Leading global companies have recognized the importance of sustainability as a strategic and reputational success factor for their business. Responsibility has moved up from investor relations to the top management agenda. MIT Sloan Management Review (Winter 2012) reports 70% of firms have sustainability on their top management agenda, compared to 20% a decade earlier according to a poll among 3,000 top managers. At the same time we have seen a continuously growing participation rate in the SAM Corporate Sustainability Assessments since 1999. And for good reasons: a company’s financial performance, including its shareholder value, correlates positively with its sustainability performance, as has been repeatedly documented in academic research. For example, SAM’s study “Alpha from Sustainability” (2011) indicates that a portfolio of sustainability leaders outperforms a portfolio of laggards. The sustainability signal was particularly strong in volatile markets such as 2008. These findings were confirmed by a 2011 Harvard Business School study. Companies have a keen and growing interest in implementing sustainability policies, especially in times of financial turbulence, in order to create a competitive advantage and long-term stakeholder value.

Institutional Investors will step up their sustainability efforts

The last decade has seen a palpable intensification of the sustainability efforts made by institutional investors. The UN PRI initiative now has over 1,000 signatories. But is this happening at a fast enough rate? The corporate sector is ahead by a decade or so.Institutional investors are in a unique position to transform today’s ‘headwinds’ capitalism into a more sustainable, wealth-creating version for current and future pensioners, less prone to generate the financial bubbles and crises of the last decade and more legitimate in the general public’s skeptical eyes. Institutional investors, and especially pension funds, are in a unique position to shape the future of capitalism because of their fiduciary duty to invest across generations without depleting socio-economic and environmental resources.

Spending time and effort on ESG will help the financial industry to regain credibility and trust by increasing transparency and focusing on long-term value creation. Expertise, innovation and leadership in the field of sustainability will define the leaders among the financial institutions in tomorrow’s world.

This article may be reproduced according to our terms of use with attribution (and link, if online) to www.tias.edu. To be cited as: “Institutional investors can shape the future of capitalism”, Eric Breen, Daniel Wild, www.tias.edu, October 12, 2012.