Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.” The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience. The goals of Five Questions about SRI are fourfold:
- To reflect on what SRI in emerging markets means to practitioners;
- To collect a catalogue of examples of SRI in practice in emerging markets;
- To raise awareness about SRI in emerging markets; and
- To enable SRI practitioners in emerging markets to network with peers around the world.
This week’s interview is with Matthew Kiernan, Founder and CEO, Inflection Point Capital Management, Canada.
Inflection Point Capital Management is a multi-strategy, sustainability-driven asset management boutique, based in London, New York, Toronto, and Melbourne. In addition to generating superior risk-adjusted financial returns for its investors, IPCM seeks to mobilize and leverage the enormous power of the financial markets, and help redirect their investment flows to promote – rather than undermine – the necessary global transition to a more environmentally and socially sustainable economy. Inflection Point’s investment research precursor, Innovest Strategic Value Advisors, was founded in 1992, one week after the historic Earth Summit in Rio de Janeiro, and was recognized as the #1-rated firm in the world in its field. Innovest’s (and IPCM’s) founder, Dr. Matthew Kiernan, was the first Director of the World Business Council for Sustainable Development in Geneva, the primary private sector advisor to the Secretary General of the Earth Summit. Dr. Kiernan had chaired the group’s initial Capital Markets Task Force. Previously, he had been a senior partner in the strategic consultancy practice at KPMG. Those two sets of experience convinced him of both the desperate need to increase awareness of sustainability factors within the financial community, and the tremendous transformational potential available if this could be achieved. His latest book is “Investing in a Sustainable World.”
Emerging Markets ESG: How would you define socially responsible investment (SRI)?
Dr. Matthew Kiernan: I think it is absolutely critical to clarify the distinctions among a number of investment styles which, while often confused and conflated, are actually starkly different. “Neo-classical SRI” is very much driven by personal values, and has historically focused on excluding “undesirable” companies from portfolios. We believe this approach to be entirely appropriate for individual investors using their own resources, but highly problematic for fiduciary investors, who are investing other people’s money, and need to serve a constituency with widely divergent values.
By contrast, at IPCM, we focus on “sustainability”-driven, or “strategically aware” investing. While certainly seeking to achieve certain environmental and social objectives, we are particularly concerned about the quality of companies’ management. We utilize their responses to a myriad of global mega-trends (such as climate change, resource scarcity and degradation, access to affordable medicines, harnessing the capabilities at the “base of the pyramid”, the growing premium on companies’ innovation capacity and adaptability, etc.) as proxies and leading indicators of that management quality in a rapidly-changing world. So we see our approach as quite distinct from SRI, albeit concerned with many of the same issues.
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
Dr. Matthew Kiernan: As I noted above, I believe that the biggest distinction is that, historically at least, mainstream investment was 100% focused on financial risk and return, as opposed to values and ethics. Environmental and social issues were viewed as irrelevant at best and at worst potentially harmful to returns (because of the portfolio exclusions for allegedly “non-financial” reasons). Today, however, we are seeing the beginnings of a convergence between what were previously two distinct investment philosophies and styles; mainstream investors are increasingly (albeit painfully slowly) coming to accept that environmental and social factors can indeed affect companies’ competitiveness and financial performance quite directly. The recent BP oil spill — and shareholders’ vigorous response to it —provide but one recent example.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for emerging market companies to manage?
Dr. Matthew Kiernan: The list of challenging issues is obviously a long one, and the priorities among them clearly depend on the particular emerging market under consideration. Having said that, if forced to choose one theme with the broadest application, I’d have to say that it is income disparity and social inclusion — how to galvanize economic and social opportunities for the 4 billion at the “base of the pyramid”. It is a fiendishly difficult challenge for companies — which is precisely why we find it a particularly robust proxy for their management and execution capabilities, and a harbinger of their long-term financial viability and performance.
I should perhaps also add that at IPCM, we take what might be termed an “ESG-PLUS” approach. In addition to the “usual” ESG factors, we pay close attention to what we believe to be other important drivers of corporate competitiveness and sustainability, such as the quality of their human resource management, their agility and adaptability, and their ability to innovate consistently. We believe that a pure “ESG” focus is overly limited, and also less likely to be mainstreamed.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for investors in emerging markets to analyze?
Dr. Matthew Kiernan: Investors in emerging markets are currently hampered by both spotty disclosure from companies and relatively poor coverage from third-party research providers. This is, inevitably, particularly true on the social side of the sustainability equation, where the issues are much less amenable to quantification and measurement. And what many investors do not realize is that companies’ exposure to these thematic risks and opportunities can vary by a factor of thirty times or more, even among companies in the same industry sectors.
The positive aspect of this, of course, is that truly robust, in-depth, on-the-ground research can pay much bigger dividends –investors with access to it enjoy a significant information advantage. Such research is clearly more time-intensive and costly, but we believe that the rewards more than justify the additional effort and cost. Two examples of important but challenging social issues with which we’ve been heavily involved are improving access to affordable medicines and creating opportunities at the base of the pyramid. As “impact investing” becomes more visible and popular, we expect that the coverage of these and other social issues will intensify.
Emerging Markets ESG: For two decades you have promoted inclusion of sustainability issues in financial analysis. Which risks do socially responsible investments in emerging markets pose to investors and which rewards can be obtained from such investments?
Dr. Matthew Kiernan: Again, please allow me to clarify: we at IPCM do not consider ourselves to be SRI investors, and we believe that the distinction is not mere semantic hair-splitting. But whether one is discussing traditional SRI or our sustainability/strategically aware approach, I think the answer to your question is the same: there are really NO risks attached to either, above and beyond the “normal” risks encountered by mainstream investors. On the contrary, I would argue strongly that both sustainability investing and SRI are actually much LESS risky than their conventional counterparts, and that is particularly true in emerging markets because of the information advantage that high-quality sustainability or SRI research can create. Investors can obtain a much deeper, more comprehensive view of companies’ strategic management and execution capabilities, as well as their true risk and opportunity profiles. In our view, this makes the investments considerably less risky and more likely to be successful.