Institutional investment management is broken.
Asset-gathering business objectives and goldplated cost structures magnify the imperative to grow AuM. Investment firms led by marketers rather than investment managers create strategies tailored to what will sell rather than what works. Large pools of management fees are required to fund large, expensive teams designed to convey analytical edge. Pressures to justify high management fees discourage investment professionals from acknowledging ignorance or mistakes and create an action bias that is incompatible with good investment outcomes.
The creation and promotion of investment strategies which will sell result in niche investment universes predicated on analytical edge, primary research methods, or proprietary idea generation funnels, all of which look ‘differentiated’ in a pitchbook. The latest incarnation of this pitchbook mentality comes in the form of ESG investing mandates.
Investors last year ploughed a record $21bn into ‘socially-responsible’ investment funds in the US, almost quadrupling the rate of inflows in 2018. The surge in popularity of companies with the best social, environmental and social governance scores in recent times has resulted in a crop of ESG funds, eager to attract some of the cyclical capital flows to this particular bucket.
Attempts to quantify skill through an obsession with measurement creates bubbles, disincentivises first principles thinking, and makes capital allocation and manager selection processes less efficient by making them more data driven. But data can be falsely empowering, unaccompanied by thoughtful qualitative review of a manager’s capacity and incentives to do a good job.
The shoehorning of ESG frameworks into existing asset management programmes and the surge in new ESG funds extend the already warped incentives in the investment management industry. Stocks with strong ESG scores are bid up as these capital inflows are put to work. Are investment managers, guided by the desire to grow assets and the employment of a quantitative ESG scoring framework, losing the facility to think independently about the sustainability and reasonable governance of companies? About the investment merits of their equity? About being socially responsible by directing endowments’, charities’ and pension funds’ capital to this more richly valued subset of the global investment universe?
ESG’s commonly accepted synonymity with ‘sustainable investing’ is especially perplexing. Who wants to own unsustainable businesses in the first place? What is investing if not the purchase of part-ownership of sustainable, flourishing enterprises? What long term business owner, managing capital for investors with long term, sometimes perpetual, investment horizons, would like the company he or she owns to be run by dishonest, self-serving managers misaligned with company owners, to treat employees poorly, create negative externalities, and exploit its customers?
Continue reading article…