Over the history of investment, we were rightly cautioned against declaring this time it’s different. Even though market history doesn’t repeat precisely, it does rhyme. The current, admittedly substantial, challenges we face may be new in magnitude, but they certainly aren’t in kind.
Inflation, supply chain woes, asset bubbles, swings between globalism and nationalism, and political risk represent the rough seas that investors continuously navigate. So it’s a truly exceptional moment when we acknowledge that there are several remarkable changes underfoot that will affect individuals, society and our economy.
As investors, it’s our job to differentiate between the transient rough seas that are the hallmark of equity investing and the truly novel changes that will become permanent fixtures in our lives. At this point in our history, there are three such changes – three things that really are different this time. Collectively, they represent a paradigm shift that will have lasting influences on capital markets and the asset management industry’s ability to generate alpha.
First is the appreciation for the materiality of environmental, social and governance (ESG) influences. The second is the growing recognition of diversity, equity and inclusion (DE&I) as an alpha generator. And the third is the unprecedented advancements in data and technology.
Fragile global marketplace
The tipping point that drove these changes to the forefront was the COVID pandemic, which exposed the fragility of a global marketplace and how interconnected the world has become. The aftermath of the pandemic continues to be felt everywhere, driving change and adaptation on an unprecedented scale and proving that the speed of evolution knows few limits when necessity demands it.
But there’s another quiet, slow, moving force that is ushering in this paradigm shift and will ensure its permanence. It’s not discussed or highlighted in a way that reflects the magnitude of its expected impact. But unprecedented demographic shifts will drive new behaviours and a significant generational transfer of wealth that will serve to materially alter the profile of key decision-makers.
This decision-making goes well beyond what to invest in. It extends to how people make choices and how information is accessed and assessed. Increasing comfort with technology, reliance on technology for decision-making, and the speed and breadth of information have made companies much more integrated into the day-to-day fabric of our lives.
This access and visibility affect our assessment of companies not just as investors but as consumers and members of the community. New tools like Glassdoor and Indeed enable us to evaluate companies through lenses other than those the company controls, not to mention simply following Twitter, looking at Yelp reviews or using a quick Google search to do research.
It’s been well established that millennials, and even much of the generation that precedes them, differ widely from Baby Boomers and the silent generation, not only in their comfort with and reliance on data and technology but also their progressive views on DE&I and ESG. And support for stakeholder capitalism mentality.
Their voices will gain growing influence as we witness the largest redistribution of wealth in human history. With an estimated 68 trillion projected to change hands in the US alone in the next two decades.
The so-called tsunami of wealth assets has been characterised as one of the most defining phenomena in financial services in the coming years. So while the current generation of investors has indeed opened the door to these profound changes, it is the shift in power to the next generation that will cement the new paradigm.
The three changes ushering in a paradigm shift will permanently influence the asset management industry and Generation Alpha in critical ways. So I wanted to shed some light on each of them.
Environmental, social and governance (ESG)
Starting with ESG, rewind the clock 10 years, and you will have found very few mainstream investors talking about environmental, social and governance influences in the way we do today.
Once dominated by values-driven, exclusions-based strategies, most sophisticated investors are now employing ESG criteria more robustly, using company operational information to both reduce risk and seek additional upside performance.
The idea that ESG information is economic and potentially material should hardly be controversial now, and yet it is. There’s been a lot of backlash lately regarding ESG and investing that comes in several forms.
First, the politicisation of ESG in the US, with some suggesting that considering ESG criteria is nothing more than a woke agenda. Second is the conflation of ESG integration and exclusions based on scores, which can result in sector biases and cyclical underperformance. And third, confusing ESG with values-based investing on one hand and impact on the other. These are three independent concepts.
But even in the presence of this, I would suggest transitory backlash, the flailing about that is occurring, is because of the paradigm shift – the growing recognition that we can’t and shouldn’t view companies in isolation. Companies don’t function in a vacuum. They operate within an ecosystem impacting their employees, suppliers, customers, and even the environment and society. Otherwise, ESG would easily be relegated to this fanciful idea that is fleeting.
Asset owners have started to recognise this and that they may face headwinds economically. And we see that play out when companies run afoul of E, S or G expectations and see their stock price plummet.
The reality is that how we evolve into an economic system that embraces all company’s stakeholders and respects the finite and vulnerable resources that underpin our economy will become increasingly critical. And investors already recognise that the business and investment winners of the future will be those firms that can bend the arc of a company from where it is to where it needs to be.
The one thing that this metaphorical hand-wringing has right is that ESG investing must evolve such that investment approaches not only assess company-level, environmental, social and governance characteristics but connect them to changes in the real economy.
This is a daunting prospect for investors because it requires adopting an impact mindset. But if we are to truly understand the effects of our investments on all stakeholders, it’s paramount that we move past ESG ratings to instead focus more directly on how a company interacts with its ecosystem and what the resulting implications might be.
Nevertheless, while ESG and impact is something, we need to reckon with acknowledging that there is a more thoughtful way to do that. There are entrenched interests that don’t want the paradigm shift to happen. But as Neil deGrasse Tyson said, ‘the good thing about science is that it’s true whether or not you believe in it’. And the massive demographic shift that’s underway will pass the reins to a generation that does believe and fully recognises things need to change. And given the magnitude of the change, we need the full heft and breadth of capital markets to play a role.
Diversity, equity and inclusion
Next, diversity, equity and inclusion. We call out DE&I specifically not because of a socialist agenda but because of its importance to society and its positive impact on broader company performance.
To be clear, the inequalities laid bare by COVID-19 have led to a groundswell of support for social justice movements, propelling issues of diversity, equity and inclusion to a front-and-centre position at companies.
More broadly, the sensitivity toward equality and fairness has been growing over recent years, and the demand for a more inclusive society is hitting a crescendo. There’s also a significant and still growing body of research that links diversity to financial metrics, including improved profitability, better employee retention, and lower investment risk. Although this is evidenced through studies and economic papers, more than it should need to be, the landscape remains largely unchanged.
The lack of diversity in key decision-making roles persists despite the acknowledgement that the diverse groups represented by people with different perspectives, backgrounds and experiences more broadly examined all sides of an issue leading to better decision-making.
We would argue that the concepts of diversity, equity and inclusion extend beyond better-performing organisations. They build resilience into the fabric of our economy and lead to better outcomes for people, society and our planet.
With this paradigm shift in investing, asset management firms are going to need to think like technology disruptors and innovators, not monolithic organisations clinging to past beliefs no longer relevant in a dynamic global economy.
To recognise or better predict the far-reaching effects of swiftly changing views on DE&I, successful companies must themselves have empowered diversity within their ranks. Nowhere is this truer than in asset management.
Capital Markets, participants must transition from passively abiding change to playing a lead role in driving purposeful outcomes that serve society and developing enduring businesses that thrive by balancing the needs of all stakeholders. To do this, welcoming historically underrepresented groups is not only a benefit but a necessity if we are to successfully navigate the changing landscape.
Technology and data
Finally, technology and data. The speed of technological innovation is staggering. And its permeation of the economy is as such that most sectors are now de facto technology sectors. As individuals, our lives are permanently altered by the rise of social media and the emergence of the digital person – one’s online identity.
Access to technology and fluency and technology use are key determinants of economic success for individuals, companies, and even countries. Profound and real change when it comes to technology is undeniable.
Data, for its part, is changing too. Access to data has increased dramatically in tandem with access to technology. But it’s the speed at which data circulates that’s truly mind-blowing. Pair this with the now decentralised nature of data creation, and it’s no surprise that data accuracy, or more generally, information accuracy is a key concern as the paradigm shift takes hold.
The asset management industry is a case study of how technology and data are dramatically altering the way investing is done. New tools like natural language processing allow for the ability to extract insights from text-based sources. Artificial Intelligence, more generally, can help bring order to the enormous volume of unstructured data generated daily. With the velocity of news and the rise of social media, companies have nowhere to hide, bringing a heightened awareness of public perception to management and often swift reactions on the part of investors.
We’re already witnessing Twitter wars on company-specific activities. Social media communities are quick to out accompany running afoul of environmental or social expectations, and in some cases, sharp stock price declines in reaction to controversial news.
Respect and accept
As noted previously, the generations that are positioned to be the recipients of the largest redistribution of wealth have much greater access and a higher standard for what they expect from companies. Not only should companies take heed, but as investors, we also need to both respect and accept the potential significant influences of evolving investor sentiment.
These three changes are not only truly different this time, but they are also new enough, swift-moving enough and unsettled enough that we are far less certain about their possible effects when compared to the more known challenges and equity market investing.
Those who remain deeply wedded to the belief that we will return to some now dead version of the status quo that existed before ESG, the push for diversity or artificial intelligence, will be fumbling to make sense of what comes next.
Equally disadvantaged will be those who find themselves within a cumbersome bureaucracy; they may actually have the desire to embrace change but not the practical ability to do so.
What these three changes and the demographic shifts that are propelling them forward and amplifying their influence have in common is that we’ve not seen them before in any meaningful way. The silver lining is that big changes, no matter how jarring,, can open us up to new ways of thinking and acting. They force us to find new solutions and contemplate new opportunities.
But let’s be clear, not everyone is happy about change. ESG, DE&I and technological transformation have met with criticism from some camps who seek to paint these changes, and the necessary response from the investment community, as some attempt at social engineering.
We argue that this could not be farther from the truth. As investors, our job is to find companies that will be resilient to change and that have management that’s attuned to evolution on these and other dimensions and working to keep their firms relevant and prospering.
The stakeholder paradigm
It’s our strongest belief that investment firms that will succeed in this paradigm shift. What we call the new stakeholder paradigm are those who are best positioned to understand the expectations and requirements of new constituents and nimble enough to pivot in a way that allows them to be the architects of their own destinies, as opposed to being backed into a corner by changes they don’t understand or unable to address.
It’s time to acknowledge and embrace what is fundamentally changing. Trying to play catch up instead of proactively leading the way will result in poor outcomes for investors. To thrive in the stakeholder paradigm, a new era for investing will take a different approach and a different type of firm.
We would all be wise to commit to an investment practice that acknowledges the rough seas of equity market investing but simultaneously welcomes the true evolutionary, even revolutionary, changes that are happening now as we shift to a stakeholder orientation, a more inclusive economy, and a faster paced, decentralised data and technology environment.
These changes collectively have the potential to make us better investors and better stewards of our client’s capital. If we better reflect the constituents we serve and commit to new ways of thinking and nimbleness in our investment process, use of technology and even in our organisational structure, the result of the new stakeholder paradigm will be a positive change in ESG issues, and positive developments on DE&I efforts, along with advancements in data and technology that accelerate progress and ensure accountability.
Collectively, these developments should lead to a more resilient economy and a much more informed approach to investing. But it will take a truly differentiated firm to succeed.
Heidi Ridley, co-founder and CEO of RadiantESG Global Investors, was the headline speaker at DiversityQ’s Women in Asset Management Summit 2022. You can find out more about the series and how to get involved as a thought leader or sponsor here: