Research argue that institutions' investment strategies may be undermining their own efforts to promote sustainability
Institutional investors may be at the forefront of the ESG movement, but a new paper suggests that they may also be contributing to the very systemic issues that responsible investors want to solve.
According to the paper from the Predistribution Initiative – a group focused on governance, investment practices, and the systemic risks arising from investments, among other areas – is rooted in the sheer amount of money deployed by large institutions into high-risk investments.
As explained in Institutional Investor, the group contends that activity is contributing to a variety of unhealthy systemic trends such as consolidation among asset managers, elevated levels of global debt, a short-term focus among corporations, and market instability.
“Capital markets have become institutionalized,” Delilah Rothenberg, the founder of the Predistribution Initiative and one of the paper’s authors, told Institutional Investor. “Pension funds, insurance companies, sovereign wealth funds and others need to deploy large amounts of capital efficiently because they themselves are so big.”
In many cases, the only way institutions are able to hit their investing targets is to invest billions of dollars in the largest public and private companies. To satisfy the return expectations of their shareholders and creditors, companies are pushed into a variety of unhealthy behaviours.
“There are incentives to layer on debt, much of which is supplied by capital markets and the shadow banking sector,” Rothenberg said, arguing that institutional capital ends up being allocated to higher-risk products such as leveraged loans, high-yield debt, and collateralized loan obligations. “Ironically, institutional investors want to integrate ESG into their process, but they also contribute to corporate consolidation and huge debt burdens.”
Companies focused on servicing debt or providing distributions to investors, the paper argued, can end up disregarding the interests of other stakeholders. They may devote less thought to worker pay and benefits, for example, or structure investments in housing, nursing homes, or utilities to maximize their returns at consumers’ expense.
Beyond that, the paper’s authors argue that asset-management behemoths bulldozing through the capital markets can raise barriers for diverse fund managers and entrepreneurs and jeopardize quality jobs. Other undesirable impacts include reduced quality and affordability of goods and services, higher asset-class correlations, eroded opportunities for diversification, and economic inequality and market instability.
“Eventually, unchecked increases in corporate debt result in increased systematic market risk that boomerangs back to investors and their portfolios,” the authors wrote, noting that large investors end up experiencing lower financial returns. Those big-picture vulnerabilities, they argued, end up ignored because existing frameworks of ESG impact and widely applied modern portfolio theory don’t capture them.
“Perversely, as major central banks globally respond to the current crisis with rock bottom interest rates and new rounds of quantitative easing (QE), investors and companies are further incentivized to increase their exposure to high-risk debt and inflated asset valuations — a situation that leaves society and markets vulnerable to a rise in interest rates or other unplanned challenges,” they said.
