Asset owners have a responsibility to consider whether their investment strategies are potentially damaging to long-term sustainable wealth creation and are, therefore, not in the best interests of beneficiaries, Harvard University’s David Wood says.
Wood, who is the director of Harvard’s Initiative for Responsible Investment, says funds have a fiduciary responsibility to consider whether their investments have the potential to damage future growth in the real economy.
“There is no point to all of the elaborate apparatus we have designed for the financial system to function, if its role is not to allocate capital to productive sustainable activity – that is an unobjectionable point,” Wood says.
“If the system is to work, investors have to keep that in mind as they invest. On the one hand, large asset owners have to consider their place in the world and their ability to shape markets.
“Markets don’t exist out there as some phantom, all-powerful thing we have to submit to. But nor should we overestimate one fund or any one group of funds in being able to shape markets. However, this middle ground is pretty big and we are all playing in it.”
As part of his research, Wood has released the Handbook on Responsible Investment Across Asset Classes, and he has previously developed a Responsible Property Investing Center.
His most recent work involves working with trustees of pension funds and endowments to look at the ways that agency issues may inhibit long-term sustainable investment in light of the failure of highly-geared and highly-financialised products after the financial crisis.
“In particular, with these funds, I am interested in their response to responsible investment – very broadly construed as long-term sustainable wealth creation – as a potential reaction to the financial crisis,” Wood says.
“We are trying to get their understanding of how agency issues unfold the ways in which decisions are shaped and constrained by the relationship between trustees, staff, investment consultants, fund managers, lawyers and conceptions of fiduciary duty.”
Part of this involves looking at what questions trustees should be asking when they look at a potential investment, and trying evaluate whether returns are generated from sustainable activity or, are in fact a zero-sum game that in the long run will result in externalised costs to society.
“How do you design a set of questions to evaluate what you are getting pitched and then how do you avoid the pitfalls of the overwhelming pressures of hitting a certain return target because that is what your beneficiaries need,” he says.
“This leads people to pitch their products within that context and maybe promise more than they can deliver.”
In keeping with his previous work, Wood says he will look to break this analysis down to particular asset classes.
“If the goal is the make markets better serve society – that is what they are there to do and that is where real wealth is created – than can you break it down by each asset class to view a central social function from which you can measure the products you are investing in,” he says.
Wood points to infrastructure where investors may see opportunities as governments try to shed debt by selling assets at fire sale prices as a pertinent example of where buying cheap and selling high may not be in the long-term interests of members.
“Part of the danger is the reputational and political risk that comes with scooping up fire sale assets,” he says.
“When we talk about the long-term we tend to be talking about sustainable investment in real economic activity that is productive and does not externalise costs onto society. A 20 year time horizon is the way that pension funds often imagine themselves to be working. But, given questions of inter-generational equity, this is a rolling time horizon.
“So, you can buy low and sell high but if what you are trying to promote is stable, productive activity because that is your role in the world than you have to have some cautions buying on the cheap and raising political and reputational risk in a way that will cost you long-term.”
Wood’s current projects include looking at mission investment by foundation endowments; research on the changing nature of the supply for and capacity to receive capital for community investment in the US, and a global survey of the relationship between public policy and impact investment.
