Social responsibility and the institutional investment community
Milton Friedman famously argued that the social responsibility of business begins and ends with the maximization of profit. Along the same lines, a large part of the institutional investment community has long seen its own social responsibility as lying exclusively in the generation of investment returns. That’s not the whole story, though.
The story so far…
Let’s start with a brief recap of an earlier post (click here to go to the original): Milton Friedman argued that the social responsibility of business is simply to increase its profits. Peter Drucker, however, pointed out that a corporation exists for the sake of society, and must take responsibility for its wider impacts on that society. I argued that it would be a mistake to think of this as a choice between two extremes, and that attitudes toward social responsibility lie, in fact, on a spectrum.
Profit maximization and the role of the agent
In this post, I consider how those arguments apply to the institutional investment community, i.e. large investment programs and the money managers that they employ. These institutional investors are generally acting as agent for someone else; a pension plan trustee acts on behalf of the trust’s beneficiaries, for example, and a money manager on behalf of the asset owner. In many cases, the role of agent brings with it the additional (and uncompromising) legal duty of fiduciary status.
The nature of the agency role has traditionally led to it being regarded as acceptable – indeed expected – for the agent to pursue exclusively the maximization of returns, single-mindedly ignoring all other considerations.
Financial markets, though, do not only affect how the economy works, they also affect how society works. So other considerations cannot be set aside without limit. The institutional investor community does not exist independently of the wider community and as the “wider impacts” that Drucker mentioned have grown, expectations are changing. Those changing expectations apply not just to the asset owners but also to their agents, with the result that a “just doing my job” defense can start to seem inadequate.
The pressure to act not merely in accordance with the letter of the law but also with a broader ethical custom is real, but inevitably vague. Perception of what Friedman called “the basic rules of the society” differs significantly between different parts of the U.S., for example, and if we attempt to take a global view, it becomes even harder to generalize.
It should be no surprise, then, that socially responsible investing has moved furthest at programs whose primary stakeholders have the clearest expectations. After all, behavior is influenced more by the social norms of those who are close than of those who are far away.
Even though the level of expectation around social responsibility varies greatly across different parts of the investment community, and even though the nature of the role of agent can dilute the impact up to a point, the general trend has been that those expectations have increased in recent years. In that sense, the greater attention being paid to sustainability within the institutional investment community can be seen as a reflection of changes in the broader society of which it is part.
Time horizon and the role of the agent
A second aspect worth noting of the role of agent in the context of sustainable investing is the question of time horizon.
The challenge is illustrated by the famous comment of then-CEO Chuck Prince regarding Citigroup’s continued involvement in the private equity market in 2007 leading up to the financial crisis: “as long as the music is playing, you’ve got to get up and dance.” At first glance, that is a nonsensical position to take; from Citi shareholders’ perspective, leaving the party too soon would have been preferable to staying too late. But, for senior staff at the bank, taking the long view and staying on the sidelines while the markets remained profitable may well have led to their being replaced by others. As Time magazine observed at the time: “they can never know for sure when the music’s going to stop, and they’d be crazy to forego all those underwriting fees for the year or two or three before it does.”
So pressure to deliver results tends to shorten the time horizon of an agent, whether a corporate executive or an institutional money manager. And being short-term greedy is not always the same thing as being long-term greedy; too short a time horizon may lead not only to harmful social impacts (as discussed above) but may also be damaging to long-term wealth creation.
An increased focus on social responsibility, and specifically on sustainability, may serve to counter short-termism. As Mark Walker, Global Chief Investment Officer at Unilever pensions, expressed it at the 2015 Russell Investments Institutional Summit: “it’s sometimes better to think of these issues as future financial rather than non-financial.”
In summary, the fact that the institutional investment community plays largely the role of agent, acting on behalf of others, has an impact on how its social responsibility needs to be framed. It does not, however, make the question go away.