CIO Roundtable

The idea of ESG investing is not new. Ancient religions laid down moral guidelines for investment, and early Methodists and Quakers banned members from participating in morally suspect trades. Civil rights leaders urged people to direct their money in ways that would influence corporate behavior.

What is new is the increasingly widespread adoption on an institutional level. As the appetite for ESG considerations increases, challenges remain on how the market can truly scale sustainable investing. Fragmented data sources, product gaps, and cost barriers may hinder broad adoption of sustainable investments. CIO Contributing Editor Amrita Sareen-Tak led a discussion with asset owners and a consultant to garner their thoughts on the current marketplace’s ability to scale ESG investing and the changes needed.

The panel included: Shuaib Siddiqui, Director, Impact Investing: Surdna Foundation, $1 billion AUM; Susan Hammel, Executive in Residence: Minnesota Council on Foundations, combined
$3.4 billion; Seth Magaziner, Treasurer: Rhode Island State Treasury, $8 billion; Xavier Briggs, Vice President: Ford Foundation,
$12 billion; and Tom Mitchell, Managing Director: Cambridge Associates, $142 billion AUA, $20 billion AUM


CIO: What does sustainable investing mean for your organization?

Hammel: Sustainable investing means achieving a sufficient financial return to achieve the mission each foundation drives, and investing in a way that is sustainable for the planet, our communities, and people. What’s new is thinking about both financial and social returns at the same time.

Siddiqui: Sustainable investing is about making investments that align with our values without risking our grant-making activities.

Magaziner: By nature, pension funds are long-term investors. We need be concerned with the sustainability of the global economy and the companies that drive it, so our pension system can adequately support those young employees when they are ready to retire decades from now.

[Board diversity and independence is a focus for the fund. The fund will vote against a director if, upon joining, the board will be less than 30% diverse, but (the fund) will also consider independence and expertise when reviewing board candidates.]

Briggs: We see sustainable investment as an important tool for creating a more inclusive economy. It aligns with our very reason for being. We [are] committing up to $1 billion in mission-related investments. We will grow the portfolio over time. 

Mitchell: Sustainable investing sharpens our insights to factors that shape the landscape of risks and opportunities for realizing clients’ objectives. Deep exploration of the sustainability of our environment, society, enterprises, and institutions is a holistic approach to diligence and long-term investing. 

For example, there are four trends that will have significant influence on the world and portfolios: climate change, growth of global population, the expansion of innovation, and changing environmental global policies. We study these trends to understand how they shape risks and reward in resource efficiency, global industry and services, human behavior, and ultimately, capital markets.

We may see a day perhaps in the not-so-distant future, where “sustainable investing” is simply described as investing.

CIO: How does your organization measure non-financial performance?

Hammel: Each institution defines [impact] differently, whether it’s targeted geographic impact or a specific mission-related impact theme. The Foundation measures impact through metrics such as job growth, wages, worker benefits, and opportunities for upward mobility, [and compares] financial performance to Cambridge Associates’ LLC US Private Equity Index. While many agencies work to standardize non-financial metric reporting, for now it’s still more like the Wild West.

Siddiqui: Because the impact investment sector is beginning to develop standards for measuring social good, we’ll tap into our experience evaluating the successes of our previous grants to measure the social impact of each investment. We create metrics tailored for each investment, for example, total jobs created and number of lives impacted. We also track the scalability of each investment, meaning how much additional capital the investment raised. Tracking this metric will help us magnify the impact of our investments. 

Briggs: We’ve seen momentum across the industry to develop metrics and standardization for non-financial performance. For example, the Global Impact Investing Network (GIIN) developed a taxonomy for impact metrics called IRIS, and many early-stage ratings systems have emerged. Organizations like the Sustainability Accounting Standards Board (SASB), and others are working to incorporate data into accounting standards for materiality. 

With the [recent] launch of the MRI portfolio, the foundation is committed to developing an impact evaluation framework and assessment tool, drawing on leading practices in the industry, and supporting the foundation and the field, not only in pipeline development, but learning over time. 

Mitchell: We use various inputs to help clients assess non-financial characteristics of their sustainable investments. We seek to understand how [managers] consider ESG and impact factors in their investment process and reporting. We work with clients to develop expectations around non-financial factors, and evaluate performance against those expectations over the duration of an investment. We also employ a combination of manager-reported and third-party data.

CIO: What are some challenges in scaling sustainable investing?

Siddiqui: One challenge revolves around defining impact investing as a sector. A common long-term challenge is ensuring that impact investments generate returns that are commensurate with the risk. Many organizations are forced to ask themselves, for example, whether an ESG Index Fund can deliver similar returns to a traditional Index Fund. 

Magaziner: The turnover in state treasurer’s job can be as short as two to four years, which is dissimilar to the longer tenure at endowments or investment firms. Additionally, the governance structure at state treasuries can make it difficult to incorporate ESG factors into investment decisions. It’s a challenge that requires constant and perpetual education of treasurers, investment boards, and staff.

Briggs: While sustainable investing is not new, it remains a nascent market. Challenges include:

• Lack of high-quality, standardized data.

• Lack of supportive policies that would help investors to engage.

• [Lack of prepared investors]—there are far more interested investors than prepared ones, so the act of building familiarity and capability goes hand in hand with tackling these other, fairly common market-making challenges.

In order to scale, sustainable investing will need to become mainstream in finance. Financial professionals need to look not only at risk, return, and liquidity, but also impact, which requires education and culture change. Responding to [investors’] demand for impact “products” is just good business for the investment industry, so we expect that literacy, experience, and capacity will grow significantly in the next five to 10 years.

Mitchell: Interest in sustainable investing continues to grow rapidly. Our concern is that there could be a rush of the wrong form of capital into a sustainable market. For example, previously, venture capital investments into capital-intensive clean power generation were one such mismatch of capital and opportunity. Investors should learn from the past, while seeking the sources of future value and where capital is needed, rather than saturated.

Art by Eleanor Davis

CIO: How can asset managers and other market participants help in scaling sustainable investing?

Hammel: Asset managers that freely share their results are an enormous resource to those just starting out in sustainable investing. The McKnight Foundation sets the standard for comprehensive transparency in sharing both its strategic framework and investee list. Showing investor commitment and experience across various asset classes is also helpful in moving away from the false notion that sustainable investing is a separate class rather than a strategic overlay to asset management.

Siddiqui: One of the most effective ways that rating agencies and sell-side equity analysts can help is to prioritize ESG factors when asssessing a company to make investment decisions. It’s crucial for investors, for example, to be cognizant that companies without robust governance practices may carry more risk.

Briggs: Market participants could significantly impact the scale of sustainable investing by decreasing the time and transaction cost involved with fundraising. For example, Community Development Financial Institutions (CDFIs), regulated institutions, typically raise capital by engaging banks and foundations individually for private investment. This is typically a time-consuming process.

In this vein, the Local Initiatives Support Corporation (LISC), a CDFI, recently issued a $100 million bond that was oversubscribed. The bond represents the first public offering of its kind, and was rated by S&P and underwritten by Morgan Stanley. This shows the potential for CDFIs to raise capital more quickly and at scale, using instruments and pricing that the mainstream capital markets are very familiar with.   

CIO: Can you share any unique ESG strategies that can be scalable?

Hammel: The Minnesota Impact Investing fund is a great example of foundations of all asset sizes, experience in sustainable investing, and risk/return profiles coming together to invest in the community. For many, it’s a first step for CIOs and investment committees in thinking differently about asset management. Through a six-month collaborative process, it enabled a dozen foundations to work together in a meaningful way that resulted in a $17.1 million commitment.

Siddiqui: Consider creating a holding company that directly invests in private companies for return and impact.

In theory, a holding company structure would allow companies and fund managers greater flexibility in building a company in several ways: reducing the need to scale and exit companies in a relatively short timeframe (three to six years), and would allow businesses to create long-term value rather than scaling too quickly. It would limit the need for fund managers to raise a significant amount of capital all at once.   

Such a holding company would allow investors to sell shares to other investors and possibly generate a dividend yield, depending on the underlying cash flows of the portfolio companies, [and] could also raise future rounds of investment as required.

[Nevertheless], as a holding company raises more equity, existing investors may risk becoming diluted. There are quite a few details to work out.

Magaziner: We launched our Bank Local initiative, which moves millions of dollars in state deposits to local banks and credit unions to encourage loans to Rhode Island small businesses. The amount deposited is determined based on loans these institutions make to small businesses in the community. These are insured deposits, which in some instances are earning a better interest rate than at bigger banks. This is a simple and scalable solution to promote local economic growth, which could be replicated across any region.

Mitchell: A few examples include:

• [Some investors] are seeding sustainable and impact strategies—both public and private—to help grow the field.

• The private markets are maturing, [with] more managers taking sustainable approaches from early- to late-stage investing.

• Large asset managers are generating an increasing number of ESG strategies that are more affordable and accessible than years past via institutional funds and ETFs.

CIO: Are there enough product offerings to meet demand? Any product gaps?

Hammel: No. There is a mismatch between investor demand and supply of quality product. Many impact funds are too small and too new to attract institutional interest. Most have high investment minimums that preclude investment by smaller asset managers. They are typically launched by new managers and lack the track record investors require.

Siddiqui: We’ve seen a significant gap in public markets. Many active investment managers invest with a sustainability impact thesis. We could invest in many managers to obtain diversification at the manager level, however, we may have a concentration of specific public companies in the underlying portfolio of each manager.  We continue to [seek] managers beyond sustainability, for example, an interesting idea may be a fund manager may build a portfolio based on the employment practices of public companies.

Magaziner: Rhode Island recently became one of the first states in the country to offer socially responsible investment options in government-sponsored participant-directed plans—the Rhode Island 529 college savings plan and our public employee defined contribution plan. There’s tremendous potential to promote sustainability through these participant-directed plans, but a lack of socially responsible target date funds is a major gap that the industry needs to fill to fully address these opportunities.

Mitchell: For those that employ hedged or absolute-return strategies for diversification, there could also be more managers that demonstrate integrated thinking about capital allocation and sustainability.

CIO: How can asset owners better collaborate to promote the scalability of sustainable investing?

Hammel: Barriers to scaling include high minimums required by many funds [and] fees for smaller investors. To scale, we need to bring [together] asset owners of all sizes so the larger owners can assist in collaboration to generate sufficient minimums necessary for managers. This is the secret sauce that enabled the Minnesota collaborative fixed-income bond fund to launch so quickly. In essence, the larger foundation anchors cleared the way for the smaller investors to participate on a scale and cost that works for them.

Briggs: The Development of the Green Bond Principles among a group of financial institutions represents an example of collaboration to make sustainable investing scalable. 

Mitchell: Asset owners can:

• Share information, insights, and lessons learned

• Collaborate to seed ideas that promote more alignment and favorable terms for others

• Be clear and direct in pushing their managers and advisers to address sustainability and impact factors in their respective practices and processes. —CIO