The investment portfolios that drive our economic system are often based on short to mid-term risk-adjusted returns, with little thought for the long-term inefficiencies and instabilities that this creates. By concentrating on short-term growth at any cost, we undermine the resources that are vital to long-term growth. Our aim is to create a principled investment portfolio that supports positive modes of production and consumption. By demonstrating its viability, we will convert other investors to this approach.
‘The best way to persuade others to take a principled investment approach is to design it ourselves and prove that it works’
Most financial portfolios focus on maximising short to mid-term risk-adjusted returns. This is understandable because returns and risks beyond a three-year horizon are practically impossible to apprehend. However, the resulting investments feed an economic system that is driven by growth at any cost and which depletes today the resources that are needed for tomorrow’s growth. Not only is this system inefficient and unsound, it also creates profound environmental, social and economic disruption; inefficiency and instability are the worst enemies of long-term investment. Few investors recognise this. Those who do are faced with a dearth of viable alternatives.
We are transforming an existing portfolio of traditional investments into one that finances positive modes of production and consumption. This directly addresses the issues of long-term inefficiency and instability by supporting sustainable and principled growth and, implicitly, reducing the flow of funds to irresponsible activities. It is both more efficient and provides a natural hedge against long-term risk. But we realise that one portfolio alone cannot transform the economic ecosystem – the volume of assets dedicated to such an approach is key to its success. So the second intent behind building this portfolio is to prove its viability and use it to convert as many long-term investors as possible to a principled asset management approach.
‘Our aim is to create a principled investment portfolio that supports positive modes of production and consumption’
There are two main challenges to overcome. Firstly, our strict selection criteria substantially reduces the amount of potential investible products. Secondly, the quotable instruments generally used by larger entities are difficult to qualify as having a positive or negative effect because of the breadth and complexity of their activities. To mitigate against these factors, our strategy is threefold: establish strong links with the few financial institutions that have been precursors of principled investing; build a network of like-minded investors for idea and investment sharing; and rely on our project work on the ground to generate new opportunities. This will allow us to access investment targets where they exist or create them where they are lacking.
We start with classic financial and risk assessment to ensure the economic merits of a target investment. Investments that pass this first screening are rated against a number of measures including environmental impact, social impact, sustainability and scalability. The final score determines whether we go ahead. It is worth noting that the assessment is done along the entire value chain of the target investment’s activities.
When it is applied over time and on a large enough scale, principled investment is inherently designed to reduce inefficiencies and systemic instability. However, it also generates a different set of risks. These include sector concentration, for obvious reasons, and illiquidity, due to a preponderance of non-quoted investments. We are developing a sophisticated risk analysis and allocation model that integrates risk premiums and illiquidity to ensure that principled investing does not result in trading one set of risks for another.
Like all of our activities, principled investing ultimately has to promote long-term change in modes of production and consumption. To do that, an investment has to be shown to deliver appropriate financial returns and positive societal and systemic side-effects. These are the criteria by which we qualify investments and measure our results. We report on them and expect to be judged accordingly.
The decision was taken in the second half of 2012 to take a traditional portfolio and make it fully principled: focussed exclusively on investing in businesses and approaches that were based on sustainable modes of production and consumption. In the following months, we developed the criteria that would underpin this portfolio and began exploring the investment opportunities that were available.
Further investigation into the area of principled investing yielded three key findings and resolutions. The first was that there would have to be a greater allocation to direct investments (private equity, project finance, etc.) than for a traditional portfolio due to the nature of investment targets and the desire to create maximum impact. Secondly, investing through public markets in a principled manner was going to be challenging due to the generally more diverse activities of publicly quoted assets. Finally, certain purely financial assets with no direct impact on economic activity (e.g. volatility arbitrage, CTAs, etc.) could be invested and not considered as “non-principled”. Two principled investments representing 5% of the portfolio were made in 2013. One in a fully sustainable private equity fund and the other in an suitably orientated European equity fund, not an optimal solution but acceptable for now.
We will have a structured asset allocation that encompasses all of the constraints created by the focus on principled investing, notably the liquidity issues raised by those assets that are not traded publicly. As for identifying investible products, particularly quoted ones, we will implement a combination of internal search criteria, co-developed products and collaboration with third parties to overcome the hurdles of this new approach to investing. We expect to be 50% invested in principled assets by year’s end.
Due to the lack of depth and breadth in the offering for principled investments, it is difficult to predict when exactly the portfolio will be fully principled, but our aim is by end of 2015. However, significant exposure to long-term direct investments also implies a slower deployment than in quoted instruments and we are conscious of that factor as well.