As the credit crunch hasevolved into a full-blowneconomic crisis, manyhave turned to the ideasof John Maynard Keynes

to provide a route map out of recession.The flurry of recent fiscal stimulus packagesall pay homage to varying degrees toKeynes’s pioneering work in the 1930s tocounter the Great Depression. Less atten-tion has been paid to date to his equallyimportant prescriptions for the investmentindustry.

Direct experience as both investor andinsurance executive gave Keynes a rareinsight as policy adviser into the psychologythat moves capital markets. His diagnosis ofthe follies of ‘irrational exuberance’ in the1920s still ring true, with his argument inthe General Theory of Employment,Interest and Money that ‘it is the long-terminvestor, he who most promotes the publicinterest, who will in practice come in for themost criticism wherever investment fundsare managed by committees or boards orbanks.’ With financial markets identified asthe primary source of today’s crisis, investorshort-termism has once again been exposedas a major factor – alongside misplacedincentives and the wholly inadequate regu-lation of risk – in the misallocation of capi-tal that has taken place over the past twodecades.

Climbing out of this morass will requirea profound rewriting of the investment

‘rules of the game’, as well as a renewal inthe professional purpose of the financialservices industry to serve the long-terminterests of its customers. Twice in a decade,ordinary savers and investors have beenshort-changed by capital markets, first bythe crash on the world’s equity markets atthe time of the dot.com boom and secondby the implosion in credit markets on theback of unchecked property speculation.Conventional theories and practices thathave passed for the investment mainstreamhave been exposed as being fundamentallyunreliable. Yet on the margins of the finan-cial world – where most innovation takesplace – Keynes’s ghost could perhaps takeheart from the rapid rise and performanceof sustainable investing strategies.

Building on the pioneering ‘ethicalinvestment’ and ‘socially responsible invest-ment’ movements, sustainable investingstrategies are based on the realisation thatthe best way of generating risk-adjustedreturns in the 21st century is to fully incor-porate long-term environmental, social andeconomic factors into investment and own-ership decision-making. A key corollary ofthis is that achieving global sustainabilitygoals, such as access to energy, health andwater, as well as protection from climatechange, will require the mobilisation andrecasting of the world’s capital markets.

Sustainable investing thus expresses anew common sense for financial markets, asillustrated in Figure 1:

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After�the�credit�crunch�The�future�of�sustainable�investing�

As�the�fallout�from�the�crisis�in�financial�marketsspreads�throughout�the�wider�economy,�Nick�Robinsand�Cary�Krosinsky argue�that�preventing�future�marketmeltdowns�and�avoiding�catastrophic�climate�changerequires�a�new�era�of�long-termism�in�investment�

This neatly reverses the traditional chainof value creation, whereby society and theplanet are regarded merely as ‘capital stocks’for investment purposes. It is this alignmentwith the forces shaping the planet that givessustainable investors a far better chance ofdelivering outperformance than traditionalinstitutions. Indeed, much of the secret ofsustainable investing’s recent growth hasbeen its ability to sniff out critical issuesbefore the ‘electronic herd’, to anticipatenew trends and to do things that seemeccentric at first, that then become perfectlynormal.

In our new book, Sustainable Investing:The Art of Long Term Performance, wehave attempted to highlight the drivers, cur-rent performance and future prospects ofthis now diverse practice that extends fromthe world’s stock markets into private equityand microfinance and involves not justNorth America and Europe, but alsoembraces key emerging economies such asBrazil, China, India and South Africa. Forus, what is stimulating about sustainableinvesting is the way in which it provides apositive agenda for action for both purelyfinancially motivated investors eager to miti-

gate risk and benefit from upside opportu-nities, and for civil society organisationsaiming to achieve social and environmentalprogress. It encompasses the growing num-bers of individual investors who wish toensure that social and environmental factorsare included in the ways they allocate theirsavings. It also draws on the rising tide ofinstitutional investors in pension funds whoappreciate the growing financial materialityof environmental, social and governance(ESG) factors. Added to this are clean techinvestors who have identified major poten-tial for capital growth in companies provid-ing solutions for the low carbon economy.

What unites these apparently disparategroups is an acknowledgement that lastingvalue can now only be created throughfresh approaches to financial analysis, fidu-ciary duty and capital market regulation.Our ‘rule of thumb’ estimate is that betweenone-tenth and one-quarter of investmentassets – which stood at US$120 trillion in2006 – are now on a sustainable investingtrajectory, with the bulk of this limited toearly stage engagement, and around US$5trillion directly managed according to avariety of ethical, socially responsible andsustainable investing styles (see Figure 2overleaf).

Investing�as�if�the�long-term�truly�matteredThe credit crunch is perhaps best seen as thefirst instalment of a wider crisis of economicsustainability, with the threats of climatechange, energy and food insecurity, as well asrising water stress, emerging as its longerburning cousins. To date, most of the impulsefor sustainable investing has come from agrowing acknowledgment of the inability oftraditional investment theory and practice toeffectively recognise both the analytical andnormative challenges posed by environmen-tal decline. But the structural drivers behindthe credit crunch and climate change are eeri-ly consistent: asset prices not revealing the fullstate of market and non-market risks; incen-tives geared towards short-term profit-taking;and a suppression of the necessary regulatory ©

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public�policy�research�–�December�2008-February�2009 193

Figure�1.�The�constituents�of�21stcentury�investment

SUCCESSFUL�INVESTMENT

depends�upon

IDENTIFYING�TARGETS�WHICH�CANPROVIDE�A�GOOD�RETURN

Which�depends�upon

A�VIGOROUS�POPULATION�OF�ENTERPRISES

Which�depends�upon

A�HEALTHY�MACRO-ECONOMY

Which�depends�upon

A�HEALTHY�CIVIL�SOCIETY

Which�depends�upon

A�SUSTAINABLE�PLANET

Source: Centre for Tomorrow’s Company (2000)

controls to ensure that private financial actionalso delivered public goods in terms of long-term stability and development. Overlayingall of this was the emergence of financial the-ories that attained the status of theology,notably the efficient market hypothesis, whichassigned an unreal perfection to the market’sability to communicate all relevant factsthrough the price of assets.

Back in the 1990s, German environmen-tal pioneer Ernst von Weizsäcker noted that‘the system of bureaucratic socialism can besaid to have collapsed because it did notallow prices to tell the economic truth’,adding that ‘market prices are a long wayfrom telling the ecological truth’ (von

Weizsäcker 1994). Negative environmentalexternalities amount to almost half ofnational income, according to one recentassessment in the USA (Talbarth et al2006), but these costs have only been mar-ginally incorporated into the prices of assetssuch as shares, bonds and property. Thecredit crunch evolved on the back of a fail-ure to properly integrate social and eco-nomic risks into the pricing of mortgagedebt; once these risks became evident to themarket as housing defaults rose, so the val-ues of once-prized assets imploded.

In the case of climate change, less than 10per cent of global emissions of greenhousegases are covered by carbon pricing mecha-

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Figure�2.�The�multiple�styles�of�sustainable�and�responsible�investing

Style Description

1.� Ethical�‘negative’�screening Avoiding�companies�on�ethical,�moral�or�religious�grounds�(e.g.�alcohol,�

gambling,�tobacco)

2.� Environmental/social�‘negative’� Avoiding�companies�for�involvement�in�environmentally�or�socially�damaging�

screening� sectors�or�practices�(e.g.�fossil�fuels)�

3.� ‘Positive’�screening Active�inclusion�of�companies�because�of�environmental�or�social�benefits�

4.� Community�and�social�investing Allocation�of�capital�directly�to�enterprises�that�explicitly�provide�social�returns

5.� Extra-financial�‘best�in�class’ Active�inclusion�of�companies�that�lead�their�sectors�in�environmental�or�

social�performance

6.� Financially-weighted�‘best�in�class’ Active�inclusion�of�companies�that�outperform�sector�peers�on�financially�

material�environmental�or�social�criteria

7.� Sustainability�themes Active�selection�of�companies�on�the�basis�of�investment�opportunities�driven

by�sustainability�factors,�such�as�renewable�energy

8.� Constructive�engagement Dialogue�between�investors�and�company�management�to�encourage�

improved�management�of�environmental,�social�and�governance�issues

9.� Shareholder�activism Use�of�shareholder�rights�to�pressurise�companies�to�change�environmental,�

social�or�governance�practices

10.� Integrated�analysis Active�inclusion�of�environmental�and�social�factors�into�conventional�

fund�management�

11.� Norms-based�screening Avoiding�companies�for�non-compliance�with�international�standards�such�as�

those�issued�by�the�United�Nations,�Organisation�for�Economic�Cooperation�

and�Development,�and�International�Labour�Organisation

Source: Eurosif (2006), Citigroup (2007), US SIF (2008)

nisms and there are no legal requirementson stock markets to integrate climate risksinto their operations. The share prices of oil,coal and gas companies, for example,remain based on the assumption that theirreserves of fossil fuels constitute assets fromwhich attractive cash flows will be derived.As a result, billions of dollars, pounds andEuros continue to be routinely misallocatedto carbon-intensive investments in spite ofunprecedented awareness of the long-termrisks of climate change.

The UK’s exposure is particularly acutewith the emissions from the facilities andproducts of leading fossil fuel companieslisted on the London Stock Exchange suchas Anglo American, BP, Rio Tinto, RoyalDutch Shell, and Xstrata accounting forabout 15 per cent of global emissions, com-pared with the UK’s geographic carbonfootprint of just 2 per cent of the world total(Henderson Global Investors 2005). Just asmost UK pension funds were heavily invest-ed in supposedly reliable financial institu-tions which subsequently proved to be poorrisk-adjusted assets in the credit crunch,they are also heavily invested in successfulfossil fuel companies which face a similarvalue implosion from the looming cost ofcarbon.

The challenge of climate change is justone example of the way in which contem-porary financial markets fail to appreciatemajor drivers of long-term value creation.In the mid-1980s, financial statements werecapable of capturing 75 to 80 per cent of therisks and value creation potential of corpo-rations. By the early 21st century, this hadfallen to less than 20 per cent, with factorssuch as human resource management andresource efficiency routinely ignored fromcore assessments (Kiernan 2007). Since thelate 1980s, sustainable investors have beenthe first to attempt to assess these factors, forexample, through the ‘best in class’ analysisof corporate performance on a range ofextra-financial factors. The results of thisanalysis can be used both to create the uni-verse of stocks (or bonds) from whichinvestors select their portfolios, and to adjustthe cost of capital based on this wider

understanding of risk (Lucas-Leclin andNahal 2008).

By definition, sustainable investing focus-es on the long-term factors that impinge onvalue creation at odds with the continuingforeshortening of time horizon among con-ventional investors. Technological innova-tion and financial deregulation have servedto make trading cheaper and easier, drivingan expansion of short-term trading strate-gies. But in addition, incentives along theinvestment chain from consultants throughasset managers to brokerage houses andcompanies themselves have been progres-sively geared to drive quarter-by-quarterreturns. As a result, the average holdingperiod on the New York Stock Exchangefell from seven to eight years in the 1950s tojust 11 months in 2005 suggesting that mostinvestors can no longer be bothered to waitfor the next annual report before trading(Montier 2007). Investing for the long-termis not just a nice thing to do: it is fundamen-tally essential if market behaviour is to bealigned to the actual needs of both individ-ual savers and institutional investors such aspension funds.

Delivering�the�goods�Investment is about anticipation, and sus-tainable investors have been first to appreci-ate the financial materiality of emergingvalue drivers in the process getting ahead ofthe electronic herd, which is now rapidlytrying to catch up. This is not just a matterof fine-sounding words, but has beendemonstrated through actual fund perform-ance. A pioneering analysis of 135 mutualfunds with extra-financial objectivesdemonstrates that the world’s sustainableinvesting equity funds outperformed themain investment benchmarks – the MSCIWorld, S&P 500 and the FTSE 100 – on aone, three and five year basis to the end of2007 (Krosinsky 2008). The analysis select-ed those funds deploying strategies 5, 6, 7and 10 identified in the sustainable andresponsible investing (SRI) styles identifiedin Figure 2; these sustainability funds alsooutperformed purely ethical portfolios. ©

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public�policy�research�–�December�2008-February�2009 195

Importantly, this analysis also shows thattime horizons matter. Those SRI funds withlow turnover substantially outperform thosewith essentially trading rather than owner-ship strategies. According to company andpublic disclosure websites surveyed in Apriland May 2008, low-turnover funds hadreturned 16.4 per cent over the previous fiveyears compared with 11.4 per cent returnsfor high-turnover funds during the sameperiod (Krosinsky 2008).1

Provisional data for 2008 itself suggeststhat sustainable investment equity fundsdeclined in line with the market, falling 42per cent – the same as the MSCI World.From a micro-investment perspective, thisresult suggests that sustainable investing canadd alpha (outperformance) in a marketupswing, but does not carry excessive beta(risk). But from a macro-perspective, therelentless loss of value for funds whethersustainable or conventional suggests that allsuffer when the market itself is structurallyunsound, requiring changes in behaviour aswell as framework conditions.

The�best�years�are�still�aheadSustainable investing has served its appren-ticeship and is set for considerable expan-sion in the years ahead as regulators,investors and companies struggle to designfinancial markets geared to the long term –and simultaneously confront issues such asclimate change. Performance is no longer

the constraint, and capital is waiting in thewings. But obsolete market structures areholding back the full potential of sustain-able investing.

The credit crunch has served as a power-ful warning of the inability of current mar-ket structures either to effectively managerisk or to deploy capital to truly productiveuses. The task ahead is to create capitalmarkets that are ‘fit for purpose’ for thesocial, economic and environmental reali-ties of the 21st century. This means updatingthe core listing and operating rules on theworld’s stock and credit markets, as Aviva’sChief Executive Officer Alain Dromer hasrecently suggested. Voluntary initiativessuch as the Carbon Disclosure Project canprove excellent testing grounds to driveinnovation. But they need formal regulationto ensure comprehensiveness and bite.

The International Energy Agency esti-mates that US$1.3 trillion a year will beneeded to drive down carbon emissions toacceptable levels (IEA 2008). Mobilisingsuch sums of capital will require action atboth ends of the value chain – not just curb-ing emissions from individuals and industry,but also curbing ‘financial oxygen’ for car-bon intensive assets. Furthermore, incen-tives for investment analysts and fund man-agers need to be refocused from ephemeralgains in short-term trading towards steadyand reliable returns over the long term. Inthe end, it means redirecting the ingenuityof capital markets so that they serve ratherthan smother the public good – for exam-

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Figure�3.�Relative�returns:�sustainable�investing�performance�compared

1�year� 3�years� 5�years�

2007� 31/12/04–31/12/07 31/12/02–31/12/07

Sustainable�investing 13.2 18.7 18.4

MSCI�World 9 12.7 17

S&P�500 5.5 8.7 13.2

FTSE�100 5.9 12.9 13

Source: Krosinsky (2008)

1. High turnover indicates a fund that changed its entire portfolio at least once a year, with low turnover indicating a portfo-lio that might take three to five years to turn over completely.

ple, designing the instruments that canaccelerate the financing of urgently neededenvironmental infrastructure as part of theemerging Green New Deal.

To realise the required structural changesin the world’s capital markets imaginativealliances will need to be made with emerg-ing sustainable business groups, key policy-makers and civil society organisations.Beyond the environmental arena, encourag-ing signs of joint ventures between investorsand civil society are coming from the healthsector, notably the creation of the Access toMedicines Index, as well as the progress ofthe Pharma Futures collaboration. Morebroadly, the social pillar of sustainableinvesting has historically been the weakest –and might appear at first sight to be intrinsi-cally at odds with the ‘fear and greed’ thatdrives financial markets.

But the world’s investment marketsthrive on the platform for long-term savingscreated by the post-war national welfarestates. During the 21st century, the need is totake inspiration from these founders and toreinvent the system of investor welfare forthe global age and the imperatives of sus-tainable development. Here, there are twourgent and interconnected priorities. Thefirst is how to mobilise pension funds andothers to back a new generation of socialequities and bonds to finance the improve-ment of education, healthcare, microfi-nance, public transport and social housing.The second is to extend the benefits of pen-sion provision to the world’s poor, withreturns generated from investments in thetype of projects and enterprises that areneeded to make the UN’s MillenniumDevelopment Goals a reality (Blackburn2007).

During the dark days of the 20th centu-ry’s Great Depression, Keynes lamentedthe odds that were stacked against thelong-term investor. ‘It is in the essence ofhis behaviour that he should be eccentric,unconventional and rash in the eyes of

average opinion’, Keynes wrote, addingthat ‘if he is successful, that will only con-firm the general belief in his rashness; andif in the short run he is unsuccessful, whichis very likely, he will not receive muchmercy. Worldly wisdom teaches that it isbetter for reputation to fail conventionallythan to succeed unconventionally.’Sustainable investing is no longer rashalthough its success is undoubtedly uncon-ventional. The scale of the investmenttransformation ahead demands a newaudacity. The challenge for sustainableinvesting is not to become like today’smainstream but, rather, to replace it.

Nick Robins is head of the HSBC Climate ChangeCentre of Excellence, and Cary Krosinsky is vice-president of Trucost plc in the USA and based inLondon. Together, they are the co-editors ofSustainable Investing: The Art of Long-Term Performance (Earthscan 2008). Theywrite here in a personal capacity.

Blackburn R (2007) ‘A Global Pension Plan’, New LeftReview, vol 47, September-October

Centre for Tomorrow’s Company (2000) Twenty-First CenturyInvestment London: Centre for Tomorrow’s Company

Citigroup (2007) Crossing the River II London: CitigroupEurosif (2006) European SRI Study Paris: EurosifHenderson Global Investors (2005) The Carbon 100:

Quantifying the Carbon Emissions, Intensities and Exposures ofthe FTSE 100 London: Henderson

International Energy Agency (2008) Energy TechnologyPerspectives Paris: IEA

Keynes JM (1936) General Theory of Employment, Interest andMoney London: Macmillan [1978]

Kiernan M (2007) ‘Capturing next-generation alpha driversThe Working Capital Report Geneva: UNEP

Krosinsky C (2008) ‘Sustainable Equity Investing: theMarket-Beating Strategy’ in Krosinsky and Robins(2008)

Krosinsky C and Robins N (2008) Sustainable Investing: TheArt of Long Term Performance London: Earthscan

Lucas-Leclin V and Nahal S (2008) ‘Sustainability Analysis’in Krosinsky and Robins (2008)

Montier J (2007) Behavioural Investing Chichester: John Wiley& Sons

Talberth J Cobb R Slattery N (2006) The Genuine ProgressIndex 2006 Oakland: Redefining Progress

US SIF (2008) 2007 Report on Socially Responsible InvestingTrends in the United States Washington DC: SocialInvestment Forum

von Weizsäcker E (1994) Earth Politics London: Zed Books

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