Why would progressive institutional investors make it tougher for themselves by choosing words that create difficulty when reaching out to unconvinced colleagues? 1
While I don’t claim to have “the answer,” this is clearly a question worth examining more deeply.
Having experienced the failure of the acronym “SEE” (social, environmental and ethical) and growing resistance to “SRI” (socially responsible investment) within the institutional investment space 2, most practitioners and commentators who want to see change in the investment system – and for shorthand I will call this constituency the “progressives” – have switched to using “ESG” (environmental, social and governance) while some have plumped for “non-financials.”
What’s in a word or phrase, you may ask? According to the leading linguistics expert and political progressive, George Lakoff, every word evokes a “frame,” and some frames are simply more powerful than others.3
Is this an interesting but essentially theoretical concern?
Unfortunately not. Institutional Investor conducted an anonymised survey of over fifty chief investment officers (or equivalents) at their March 2005 European Institute event. Participants were asked to indicate which phrase best captured this subject area [see box 1]. “Non-financials” and “ESG” came last and one but last respectively!
Box 1: Words Matter to Investment Decision-Makers
The Audience Was Asked to Say Which Phrase Best Captured This Aspect of Corporate Performance and Associated (Investment) Analysis. the Results Were_
- Long-Term Value Driver (50%)
- Intangible (16%)
- Enterprise Risk (14%)
- Extra - Financials (11%)
- Environmenta L, Social, and Governance (7%)
- Non-Financials (2%)
Some readers might feel these results could have been predicted. How better to turn off financial professionals – who often believe in a very traditional and narrow definition of fiduciary duty – than to use a phrase which, at best implies that the subject matter is a second-order consideration, and at worst negates the person’s core professional competencies! And why should “ESG” do so much better than the failed “SEE” just because it has one less “E” and one more “G”?
What is surprising is that even when faced with this information, many who seek to engender change still insist on using these ineffective phrases. Faced with worrying data, albeit from a small survey, one might expect those who have much invested in the success of this development to commission more detailed market research. No one has reported doing so. The obvious question is why?
One conclusion may be that the new breed of producers who service – and rightly hope to profit from this market need – are keen to retain the language of their specialisation. Hence the stress on the three component parts – “environmental, social and governance.” Creating a parallel specialist unit is a widely used strategy to achieve change in many organisations but whether this strategy will work, or whether these units will simply go the way of other in-house boutiques within investment firms, is unclear. Evidence in support of this hypothesis could be that many of the firms who have taken the route of setting up specialist units have indeed chosen to use the ESG language.4
Another conclusion: Organisations who face internal debates over whether and how quickly to acknowledge this “new” agenda may feel more comfortable with a phrase which acknowledges the primacy of the financial and hence gravitate to using “non-financial” to cover the rest. Evidence in support of this hypothesis could be that “non-financials” is often used by organisations where there is no clarity yet about how this new paradigm fits with the existing business model (e.g., the big four accounting firms5) and also by associations where there are many different views on the desirability of this new agenda (e.g., International Corporate Governance Network and National Investor Relations Institute 6).
A third possibility is that, at present, there seems to be no significantly better alternative. The survey showed one clear favourite – “drivers of long-term value” – but this phrase fails to capture the risk dimension, which is arguably the bigger factor. The exclusive focus on use of the “long-term” – when many investors know that even Keynes said, “In the long-run we are all dead” – is also problematic. “Intangibles” is a term which isn’t easy to grasp and “enterprise risk” as a phrase has traction only in North America (and is also unfortunately linked to Arthur Andersen and former clients like Enron). McKinsey & Co. have taken to using “corporate health,” the EU Commission talk of “Key Performance Indicators,” consultants about “comprehensive business reporting,” and so it goes on.
But perhaps the real paucity with which we are struggling isn’t primarily about the absence of a good enough phrase. Perhaps it is a paucity of investment beliefs and mental models. In such a situation, to search for the perfect spin is to look for a holy grail. What Lakoff is at pains to stress is that “Frames form a system. The system has to be built up over time. It takes a long-range effort... Most of this system development involves moral and conceptual frames, not just communicative frames. Communicative framing involves only the lowest level of framing.”
There is little doubt that institutional investors operate on some well-established conceptual frames underpinned by effective global systems of training and aculturisation. 7
Modern portfolio theory and the efficient market hypothesis are perhaps the two central ones and from these theories come all sorts of “givens.” For example, the absurdity of long-term investors making “volatility” – performance over short-term intervals compared against an index or a peer group – the primary risk indicator they have to manage.
The good news is that a few investment theorists and a growing number of practitioners are making progress toward a new investment paradigm. Keith Ambachtsheer, for example, talks convincingly about an “integrative investment theory.”8 Asset owners are increasingly speaking of being long-term or responsible investors or both.9 The definition of “responsible” here is often a primarily economic one, so taking into account the fact that large funds have members with widely differing ethical and political views, and typically includes corporate governance, human capital, and eco-efficiency issues. The new paradigm also includes the understanding that large asset owners, like pension funds and insurance companies, have interests which are unique, given they will always own a slice of the investment universe. 10
With this definition of what “value” means and whose “values” count, perhaps there is, after all, a good enough phrase: “extra-financial factors.” This is the phrase that members of the Enhanced Analytics Initiative (EAI) have chosen to use.11 One interesting feature of this group is that it includes both pension funds and fund managers, firms with strong SRI roots and those who are fully mainstream and who are not convinced by the SRI product range. Perhaps even more interesting is that these firms are putting their own money where their beliefs and words are, by allocating a minimum of 5 percent of their commission payments to sell-side analysts who excel in their coverage of extra-financial factors.
One thing is important to stress. The “extra” in “extra-financial” isn’t because that these factors don’t have a measurable financial impact on corporate performance – increasingly we are finding they do – but rather, it reflects the fact that these factors often lie outside the attention span – and expertise – of the average investment professional. They are fundamentals which are often ignored in much but not all fundamental research today. If EAI and related initiatives succeed, this situation will, in many ways, be resolved. In that sense, perhaps the best phrase for this agenda is “not yet financial.”12
- A similar question has been raised regarding the use of the term “corporate social responsibility” by advocates of change. See, for example, “Daniel Yankelovich: The Thought Leader Interview,” strategy+business Issue 40, in which he says: “The corporate social responsibility movement unintentionally created a backlash against itself.”
- This article focuses on the debate relating to institutional investment. It seeks to make no comment on issues relating to the retail investment community.
- These include buy-side firms in the UNEP FI Asset Management Working Group, sell-side firms like Citigroup and Goldman Sachs, and the UN “Principles of Responsible Investment.”
- See, for example, the speech by James Turkey, chairman and CEO, Ernst & Young, to the U.S. Chamber of Commerce, December 1, 2005 (“Our Role in the Capital Markets…and Our Purpose as Professionals”) where he says: “Globally we are seeing an increase in efforts to present more forward-looking and non-financial information of value to investors, but progress is greater outside the U.S. than inside.”
- See article by Louis Thompson, president & CEO, National Investor Relations Institute, titled “The Directors’ Intelligence Link, Directors & Boards, Fourth Quarter 2004” where he says: “Directors need to know what drives the company’s shareholder value. Increasingly, what drives long-term value are not quarterly earnings but non-financial factors, such as the caliber of management and its ability to deliver on the company’s strategy; the quality of its corporate governance; what the company is doing.”
- These include the CFA examination and the way analysts are recruited, incentivised, and promoted. A study of young analysts showed they were in fact more resistant to considering these issues than their more experienced peers: http://www.unepfi.org/work_programme/investment/materiality/b eacon/
- The UN Principles of Responsible Investment, the UK-based Marathon Club, and the CFA Institute’s forthcoming project on long-termism are important indicators of this development.
- See “The Universal Owner’s Role in Sustainable Economic Development,” J P Hawley and A T Williams, Corporate Environmental Strategy. Vol 9, No 3 (2002).
- For further details, see www.enhanced-analytics.com.
- Credit for this phrase goes to Paul Lee at Hermes Investment Management.