aiCIO's Year in Review: A Profile of No One

Corporate Pension Fund X, Anywhere, USA, 2010… 

The first order of business is to convince him you’re not a Marxist hippie. This is not easy. When he takes a gander at his schedule for the morning and sees you on it, you and your commie-sounding imprimatur (some label like “Blue Heron Capital” or the “Forum for a Sustainable Future”), he automatically assumes you’re pitching an alpha-crushing dream of green pastures and butterflies. Then—you actually step into his office. If you have any sense about you, you’re sporting a somber tie and a close-cropped hairstyle, blending in as best you can with this foreign world. Helloooo?, he says, elongating the vowel to signal a hint of suspicion. What can I help you with today? 

It’s best not to mention certain words. “Green” is one of them. “Social” and “responsible” are both borderline. Banish the word “environment” from your lexicon. But you have to start somewhere. Let’s look at the great macro trends of the 21st century, you say. Urbanization. Resource scarcity. Population growth. How are you integrating this with your investment analysis’? 

It is now that his eyes start to droop, or, if you’re really lucky, actually roll back in his head. If he’s honest with you, he’ll say he isn’t considering such factors. If he’s trying to pepper the gumbo, he’ll say he is. Either way, he’s not doing it—because no corporate pension CIO is. Fiduciary responsibility, they blurt out when challenged. I have a fiduciary responsibility, and if I invest based on these principles, on green, on responsible, on doing-good-by-investing-good (the words slightly spat from the mouth) then I am going to breach that responsibility, and then I’m screwed! 

But, you think, but don’t say—for no one will believe you yet, because in America, in 2010, amazingly, despite all the science and emerging studies showing it to be true, they don’t get that this is essential—you’re screwed if you don’t… 

Harvard Initiative for Responsible Investing, Cambridge, Massachusetts 

Mmmmmmmmmmmm. This is nice. Ethically sourced coffee, poured Africa-hot. Bold. Earthy. And thank God…the Starbucks cup it sits in is recyclable. But what else would you expect at the Mecca of Liberal itself, Harvard’s Kennedy School of Government?

Well, you might expect this: “There is a self-affirming machismo with alpha seeking.” Ladies and Gentlemen, meet David Wood, the director of the Harvard Initiative for Responsible Investing, a group a few members deep, jammed into one moderately sized room, that could be considered the anti-Tea Party: soft-spoken, reasoned, and entirely on the left end of any conceivable spectrum. “Many investors look at it”—it being socially responsible investing (SRI), or environmental, social, governance investing (ESG), or sustainable investing, either one will do, although the nomenclature battle is far from simple—”through a gendered lens: ‘Big Men’ search for alpha, ‘Little Girls’ focus on this stuff.”

David Wood may not be the best man to preach this Gospel to corporate defined benefit plans. Sitting in a spare conference room at the Kennedy School’s Cambridge campus, he wears a loose, collared shirt, somewhere between office attire and lumberjack. His hair is short and unkempt. He doesn’t hold his tongue. He is unabashedly intellectual— who speaks of investing in gender terms?—and carries the practiced insouciance of academia. In a corporate office focused on liabilities, longevity, and manager selection, Wood’s demeanor likely would be met with a polite smile and quick dismissal. Luckily for his pride, then, he doesn’t see the inside of many corporate offices, for the Initiative has seen little to no success with such plans.

Doubt over the science of climate change—or “science”, as 48% of the American populace would assert, hands raised in air quotes—is partly to blame. (Although the modern mutation of socially responsible investing encompasses many facets, climate change is still a large part, both perceived and real, of its raison d’etre.) Anecdote is a fool’s form of evidence, but an unusually frigid winter from Texas to the Carolinas hasn’t helped the global warming cause; “Snow Takes Rare Whack at South,” is not a headline that precipitates concern for the hapless polar bear losing the ice shelf it calls home. Those toff East Anglian climate scientists and their indiscrete electronic correspondence haven’t helped either…

…but there is something more fundamental at work, Wood believes. “We have a certain way of conducting debate in America,” he says. “We have a deadlocked political system. In Australia, they’ve had a horrible drought, and that’s shifted the debate. But here, without some pressing problem, political discourse has deadlocked, and that seeps out.” To David Wood, the Glenn-Beckization of America—where it is acceptable to scream at your senator in the August heat of a Town Hall after lecturing your children on table manners, where “YOU LIE!” is considered nuanced debate—is at least partially to blame.

Yet, this osmosis of shriek has not entirely enveloped America’s capital pools—if it had, Wood would likely be pursuing alternative avenues of remuneration. Public pension plans, often at the whim of elected officials (and, it must be said, invariably performing poorly relative to their private cousins), are increasingly open to investments predicated on more than alpha. Foundations are even more receptive, which should not surprise given their explicit mission to help others.

What might be surprising is how even this second group… the goody-two-shoes of investing, the brownnoser with an apple for the teacher… has yet to fully embrace the principles espoused by SRI/ESG advocates. While the Harvard Initiative houses More for Mission, a program under director Lisa Hagerman that seeks to convince America’s foundations to allocate capital towards investments that align with their calling, success has been measured in inches, not feet. The $2.5 billion Annie E. Casey Foundation dedicates $125 million to mission investing, as it is known. The $600 million Meyer Memorial Trust allocates $200 million towards the cause. The F.B. Heron Foundation—considered a leader in the field—puts 50% of its $330 million into mission investments. Hundreds of millions is nothing to scoff at, of course, but you wouldn’t be out of line if, upon viewing these figures, a little voice of doubt asked: Is that all? 

”It’s a work in progress,” Hagerman says. “It was a 2% campaign, but that was too limiting—too small for some foundations, too large for others.” In response, the More for Mission goals have been made more flexible, and foundations have committed to these looser targets at a steady pace. Still, there is much to do. “We’ve had success, but so far, the largest foundations—the likes of the Gates—have eluded us.” (The Bill & Melinda Gates Foundation is the big fish of this world—and, as of now, has yet to be bagged by SRI/ESG advocates, although this is not to say that they haven’t tried: Recently, advocates went after the $30 billion fund, alleging that the very poverty the Gates was seeking to eliminate was being perpetuated by companies—oil giants, mostly—that the Foundation’s Trust arm was investing in. The Gates promised an extensive review that never materialized, and the big fish still swims free.)

This is a world of small victories. One percent of assets here…two percent of assets there. The rejections might not be as quick, the discussion more respectful—”We were seen as hippies and nuns, now we’re seen as grown-ups—look at Al Gore’s success,” David Wood says—but the march is a slow one.

To the True Believer, this utter half-assed-ness offends. Two percent, he murmurs. What’s 2% going to accomplish? It’s 100%. One hundred percent, nothing less, because it’s not about values—It’s about alpha. While it might seem a gimmick…To the True Believer, this utter half-assed-ness offends. Two percent, he murmurs. What’s 2% going to accomplish? It’s 100%. One hundred percent, nothing less, because it’s not about values—It’s about alpha. While it might seem a gimmick…suuuure, you’ll see alpha investing this way, we promise… for the True Believer it is anything but.

The True Believer sits on the outer edge of a spectrum populated with a seemingly endless variety of characters: the politically motivated denialisty… the honest opponent… the closeted opponent, clothed in a thin veneer of disdain… the frank skeptic… the reformed hypocrite jumping on the bandwagon with little conviction and even less understanding… the lip-service provider, whispering the right words to bed the girl… the believer, but for social missions…and then, out here on the fringe, the True Believer, preaching a strategy of absolutes—

—“It’s not absolutes. That’s the wrong way to look at it,” says Matthew Kiernan, a bespectacled Canadian proponent of what has emerged as the cutting-edge of this field. “It’s a matter of investing as an expression of personal values versus an investment strategy.” Kiernan believes that the latter is simply the evolutionary descendent of the former; the neo-classical, Grand Old Men of SRI (you’ll underperform, but you’ll sleep better at night) being surpassed by an ESG-preaching younger generation (alpha, alpha, alpha). “With the old model, social investors would see an action—a company making birth control, for example, or working in South Africa—and that’s all they’d need to know. With this new model,”—the True Believer method—“we throw a huge pile of social and environmental issues on the table and then use them to judge the management of the firm. It’s just as much about the ability to manage risks as about doing good.”

Other True Believers are even more critical of the 2% crowd. Jon Entine—a monologue in human form, a baroque bundle of adjectives known throughout the SRI world as an honest, if vocal, critic—is one such man. “Traditional SRI was wrong on two accounts,” he starts. “One: there were all these different standards—conservative, religious, anti-war principals of the 1960s, economic and social justice—and they often contradicted each other. You just picked some standard. It was not universal, and thus it was relative. Second, the illusion that the buying and selling of stock impacted actions of companies was just that: an illusion. But this was, for many years, the lifeblood of SRI. Only now, with the slow move away from this litmus test investing”—the pejorative avoidance of guns, gambling, and other cardinal sins—“are things changing. We were the BMW generation; we thought we were enlightened post-graduate affluent hippies, but we were making misjudgments about what was good and what was not. Organic food, for example, is not the way to feed the world.”

Echoing Kiernan’s tale of SRI’s evolution, Entine sees the new model of investing as a much-needed advance in this cloistered world. Yet, ever the iconoclast, he continues to find fault: “I have one caveat: the pitch of SRI proponents to its clients”—the endowments, pensions, foundations, insurance and sovereign wealth funds that control much of today’s capital—”is disingenuous. ‘Buying and selling of stock can change the game,’ they say. That’s a legacy of the past. They are selling a false bill of goods. What they’re actually now selling is power.” This power isn’t always being handled with care, Entine believes. “Funds like CalPERS, CalSTRS, they are being handed power, and it’s not always being used judiciously. They still haven’t shaken the litmus test issue, haven’t moved to actually looking at a company’s ability to manage sustainability risks.” This is where Entine-as-monologue really takes off. “Take housing, for example. The bubble was driven by banks and bad lenders that took advantage of a system—but it was also driven by pension funds, advocacy groups, congressional liberals that thought there should be a free lunch. Pension funds jumped in because they thought they were actually benefiting people who could not pay. This really was a conspiracy of the well-meaning left and the money-interested right.” In Entine’s eyes, pension funds and other asset owners still take up social issues outside their mandates—Shelter the poor! Feed the homeless!—in a vain attempt to act as the Benevolent Monarch rather than the steward of others’ assets. Yet, hope persists. “ESG investing will only become prevalent when it is seen as divorced from liberal litmus test categories. To a degree that pension funds focus on this—with funds like CalPERS in the lead—it will set a precedent that all pension funds move to, because…”—and here’s the kicker, the revolutionary end-hypothesis of the ESG-as-alpha model—”…if they want to fulfill their fiduciary mandate, they can’t ignore it.” 

This paradigm—that how a company handles its environmental, social, and governance risks indicates how well management will be able to deal with the full spectrum of future threats to its business—still sits closer to academic theory than applied investment practice. Of course, practical strategy starts somewhere; Markowitz’s modern portfolio theory was once simply an idea (one that Milton Friedman originally claimed didn’t even qualify as economics) batted around a smoke-filled Chicago faculty lounge. How to get it from intellectual missive to commonly accepted practice, however, is another matter entirely.

New York City ai5ooo CIOS Conference, May, 2010 

Any investment conference panel that begins with a projected slide of Plato’s Cave is either going to be phenomenal or a total flop. There is no in between.

”Look at this. This is what happened to me. I’ve seen the light, like the chained man watching shadows on the wall who realizes that they are just shadows and that the real knowledge is outside,” says Angelo Calvello. Known to all as The Doctor, Calvello is part of the True Believer school—and the moderator of a panel being held at the Ritz Carlton Battery Park on the tip of Manhattan. “Environmental investing is all about risk management. I don’t care if you believe. I am not here to defend science—but the people who deal with policy and regulation, they will put in place changes that encourage some types of action, discourage others. It’s a fact.”

Sitting on the panel that The Doctor moderates are two asset owners—one state pension fund chief investment officer, one insurance fund investor—as well as the aforementioned Canadian Matthew Kiernan. The Doctor walks them through the paces.

Pension fund investor: “As a fiduciary, we must understand our beta. It is about prudence. We model for all sorts of risk, but not for climate risk—why?”

Insurance fund investor: “In insurance, I think in terms of risk management. One example: A local county recently went entirely to alternative-sourced energy. When an entire county can go off the normal power grid—what does that do when I own large amounts of shares in large utility companies?”

The Doctor, in response: “It’s about alpha, not absolution. I am not talking about SRI—I am talking about risk-adjusted returns. There is a big difference between social investing and what we’re doing here. It’s part of the fiduciary duty to pay attention. In the future, we will be doing climate stress-tests on a portfolio.”

Then, it’s the diminutive Kiernan’s turn. (In person, he’s even livelier than over the phone.) “The notion of fiduciary has been utterly bastardized. They say they can’t do it—they say it’s against their fiduciary duty. But the notion of fiduciary is slowly being turned back to its original purpose: to take into account all risks to a portfolio.” Here, as if to match Jon Entine’s ability to reach the pantheon of oratory’s Greats, he launches into an extended thought experiment.

”They see it as a waste of time and as alpha-destruction. It makes me think of a meeting of the Flat Earth Society, where some guy breathlessly runs into the room with a picture. ‘It’s from space,’ he says. ‘You won’t believe this.’ So the Chairman of this esteemed society takes a look, and, indeed, it shows the earth in all its spherical glory. ‘There must be a speck of dust on the lens,’ the Chairman responds, and the Flat Earth Society continues on its ignorant way. That’s what’s happening here.”

The panel winds down, the point made. In the front row of the large ballroom, a corporate plan CIO sits, grinning. Or maybe it’s a grimace.

…Meanwhile, Back at Corporate Pension Fund X 

The small of your back is damp, clammy sweat marrying your skin and shirt. This is bad, you think. This is truly bad. You’ve been here five minutes and he’s already lost interest. He’s scrolling his Blackberry, nodding his head at breaks in your sentences, but then he starts typing and you know he’s entirely someplace else. Your face turns a pale shade of red as Jon Entine’s words echo around your cranium: “If a pension thinks they can stand outside this, they will be accused of breaching their fiduciary role.” But how to convince him? 

But you don’t need this indignity. You stand, picking up your worn-leather case. You consider telling him how brutish he is, how he’s missing the point, blinded by his political affiliation and unwillingness to give up his SUV; how the long-term macro trends all point towards warmer temperatures, greater competition for resources, and overcrowded cities; how there exist risks beyond reputation and counterparty credit and interest rate that he must take into consideration when he’s choosing a private equity firm, asset manager, or mutual fund. But you abstain. He won’t get it, you think. It’s too early in the process, and he still thinks of us as a bunch of bearded beatniks who were tear-gassed in some Chicago street in ‘68 while he sat sequestered in the university’s Masters’ program. You turn to leave.

But then—the unexpected. Words that stop you at the door; words that simply might signal curiosity—but paradigm shifts don’t just happen in one meeting. Hold on, hold on, he says. Tell me more….