07 Sep 2020
Over the years there’s been many missionaries forge their way into the heathen jungles of capitalism in a bid to civilise the capitalist dangers lurking there. We’ve had the messages of Triple Bottom Lines, Corporate Social Responsibility, now ESG – environmental, social and governance – reporting.
Capitalism though has proved a nearly impenetrable jungle. Yet history tells us (and I won’t push this metaphor any further) rather than clear the jungle and replace it with exotic crops, better to recognise and harness the value of the biodiversity.
“Most credible economists and policy makers recognise we need a better way to manage capitalism and the latest version of this is stakeholder capitalism.”
Capitalism works. It has reduced poverty and improved the welfare of societies around the world, vastly more than any alternatives currently tried, notably central planning. McKinsey suggests comparing West Germany and East Germany; South Korea and North Korea; Costa Rica and Cuba.
The issue with capitalism is not the theory – free markets allow for the most efficient distribution of society’s resources to grow the total size of the economy. The issue is human nature and inefficiencies in information distribution.
That’s why we see outcomes like growing wealth disparity – those with money and power can game the system absent due regulation and enforcement – and insoluble problems like the tragedy of the commons – where everyone benefits from a resource but no one pays for it, leading to its terminal exploitation.
Meanwhile, as McKinsey notes, “there is a term for an enlightened company with the most perfect intentions that does not make money: defunct”.
Not new challenges
Markets require clear pricing and the absence of “information asymmetries” but in the real world these conditions don’t exist. Sometimes because measurement is complex – the negative externalities of carbon dependent industries, for example, or the benefits to everyone from health and education systems. Theoretically, markets should be able to provide aged care but they haven’t because price signals have rewarded owners for better marketing and lower costs, not better aged care.
These are not new challenges, they have always existed in human societies in one way or another although they have become greater and more corrosive since the industrial revolution.
Most credible economists and policy makers recognise we need a better way to manage capitalism and the latest version of this is stakeholder capitalism – a capitalism which rewards all participants in an economy, all of us, not just the owners of capital.
Crucially though, this is not through central planning or even a much heavier, more visible hand of government, but through the recognition all stakeholders – including shareholders - do better if an economy is run sustainably, with equal opportunity and with as few economic rents as possible.
In an interview between ANZ’s chief executive Shayne Elliott and Nathan Parkin, as part of ANZ’s ESG investor day this week, Parkin, a very prominent and early adopter of stakeholder capitalism principles, explained the rationale – not least the significant costs, in both the short and long term, associated with businesses which ignore their broader impact on society.
Parkin is the Investment Director and Co-Founder of Ethical Partners and has 25 years’ experience in Australian financial markets including as Deputy Head of Equities at Perpetual Investments.
He argued using ESG lenses across businesses was actually no different to analysing their financial statements and risk management.
“It's really the same thing,” he said. “When we started Equity Partners we deliberately made the decision to put ESG factors into our investment process. We think companies that are very conscious of being responsible in a social way, in the human rights way, in an environmental sense, usually have good governance to back that. So why wouldn't a more responsible and socially aware business have more success?”
This is essentially the thinking behind the emergence of not just specialist ESG funds but the far greater use of broader investment metrics by major institutions globally. This weight of money is telling but also amplifies the impact on company behaviour – in most cases well ahead of governments or regulation.
According to Bloomberg, global ESG assets are on track to exceed $US53 trillion by 2025, representing more than a third of the $US140.5 trillion in projected total assets under management, assuming 15 per cent growth, half the pace of the past five years.
Far from clear
Meanwhile Bloomberg argues “a perfect storm created by the pandemic and the green recovery in the US, EU and China will likely reveal how ESG can help assess a new set of financial risks and harness capital markets”.
While early indications are investors who pay attention to ESG filters do better, the future is far from clear. There is, as yet, no clear agreement on precise metrics and - just as they have gamed capitalism throughout its history - some players will try and game ESG analysis for marketing and rent purposes. “Greenwashing” is just one example.
For example, in a particularly acute interview with the Financial Times’ must-read Moral Money newsletter, the former head of sustainable investing at BlackRock Tariq Fancy argued ESG funds “have misrepresented what they’re doing, which is this idea that you could put ESG factors in all these processes and then get better returns and better societal outcomes at the same time”.
“The value of ESG data to most investment processes, I felt, was very limited,” he said. “It’s potentially a dangerous placebo, a lot of marketing that answers inconvenient truths with convenient fantasies.
“If you believe in the ESG thesis — that responsible companies do better — then I would argue that the best thing we can do is not to just say it and then go put your money in. It would be to actually make sure that regulation is smarter, in particular by penalising irresponsible behaviour at a systemic level, because it is going to help ESG products far more."
Essentially Fancy agrees with the thesis of ESG and stakeholder capitalism but, as always, the challenge is in the measurement and market signals. At the end of the day, price signals like taxes and fines have a very direct affect. The test for stakeholder capitalism will be superior risk adjusted returns over the longer term. And that involves measuring the risk of not doing something – always difficult.
A lot will come back to familiar investment criteria. According to Parkin “it's about identifying those risks and opportunities, systematically talking to people about their approach to capital and people management. (Identifying) those companies that are more aware of future trends and in their business decisions, understanding what their customers want and need”.
Still, the mood towards stakeholder capitalism, however flawed, is a welcome shift from those who mangled Milton Friedman’s famous phrase to mean a company’s only duty is to lift next year’s earnings number.
McKinsey, among many, has done the numbers: there is growing evidence that companies which take a long-term view - and stakeholder capitalism requires that - perform better. In a study that looked at 615 large- and mid-cap US publicly listed companies from 2001–15, the McKinsey Global Institute found those with a long-term view outperformed the rest in earnings, revenue, investment and job growth.
Other McKinsey research concluded companies with strong ESG norms recorded higher performance and credit ratings through five factors: top-line growth, lower costs, fewer legal and regulatory interventions, higher productivity, and optimised investment and asset utilisation.
That is, good capitalism.
Andrew Cornell is Managing Editor of bluenotes
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
07 Sep 2020
14 Sep 2021