What did the history of sustainability investing teach you?
David Blood: Sustainability investing has a long history, starting back with the first wave of negative-screening strategies, where investors excluded entire sectors based on a set of ethical criteria. This strategy remained niche; returns were lackluster due to the fact that your investment-opportunity set was limited. The next wave of sustainability investing was called the positive-screening, or best-in-class, approach. That’s the philosophy of the Dow Jones Sustainability Indexes and the KLD Broad Market Social Index—these indexes replicate the underlying benchmarks but select only the best performers on environmental, social, and governance parameters.
However, the problem with this approach is that it’s difficult to get a real sense of what’s happening in those businesses, because it’s basically a one-size-fits-all approach, often using questionnaires for decision making. In addition, often one team does the sustainability research and then hands it over to the investment team to do the financial research. That approach, we believe, has too much friction in it because it misses the explicit acknowledgment that sustainability issues are integral to business strategy. So in setting up Generation, we saw the need to fully understand sustainability issues alongside the fundamental financial analysis of a company.
The Quarterly: What do those executives and companies that are doing this well see differently?
David Blood: The first is that they understand their long-term strategy. Secondly, they understand the drivers of their business—both financial and nonfinancial. The leading CEOs are the ones who explicitly recognize that sustainability factors drive business strategy.
In our minds, the best businesses have always understood the importance of culture and employees and ethics. And they get it in their soul. But what’s now becoming true—particularly for the industrials, the retailers, the pharmaceuticals, the utilities, and a broader array of industries—is that managers are realizing that there are broader factors affecting how they operate. They can recognize that over the next 25 years their strategy will depend on leveraging new opportunities and must operate within the changing context of business.
The Quarterly: Is this approach possible in all sectors? Clearly, the pharmaceutical industry is an interesting case. Can you get there in tobacco? Fast food? Or are these just sectors that are fundamentally, somehow, no-go territory?
David Blood: There are material sustainability challenges in all industries. In the fast-food or food-manufacturing industry, there’s a very strong move toward healthy living and eating, organic food, and the implications for sustainable agriculture. And how do food companies deal with the upstream challenges of these trends, challenges such as water use? While we don’t invest in it, the tobacco sector faces a whole host of issues which are very much sustainability driven—not just the health impact of the product. But, again, sustainable agriculture is a big story, as is litigation risk. In another sector, like financial services, the key sustainability issue is how a company manages its human capital. In the energy sector, climate change is one of the most significant issues. In the health care sector, we look at ethical marketing practices between companies and doctors. Even in industries like luxury goods there are issues around excessive materialism, authenticity, and consumption.
What I’m describing here is what we call a materiality-based approach to investing. Rather than looking at 50 different tick-box sustainability criteria, we think you need to tackle the three or four long-term issues that will really affect corporate profitability.
The Quarterly: Any final thoughts for executives trying to understand this trend toward sustainability investing?
Al Gore: Be part of the solution and not part of the problem. Your employees, your colleagues, your board, your investors, your customers are all soon going to place a much higher value—and the markets will soon place a much higher value—on an assessment of how much you are a part of the solution to these issues.
