Joe Keefe, President and CEO of Pax World Funds, gave the following speech on November 14 on the occasion of the SRI Conference 30th anniversary. I reproduce the speech here for those who could not make it to this important event and because I believe Joe Keefe captured the essence of #SRI30.
Note that Pax World and many other funds at the SRI Conference would benefit from enactment of my SEC rulemaking petition to require close to real-time reporting of proxy votes in machine readable format. Joe Keefe and Pax World have been doing this for years, demonstrating consistent leadership. When investors can easily compare voting records, funds like Pax World will be recognized as having a competitive advantage over Big Four “ESG” funds, not just for alpha but because they are voting for a better world through their proxies. See, for example, Morningstar Direct Uncovers ESG Hypocrites.
I have worked in the sustainable investment industry since 1997 – 22 years – and I would say that I have seen more change in the last 2 – 3 years than over the previous 19 – 20. Much of this represents genuine progress, which gives me some degree of both satisfaction and hope, but it also comes against the backdrop of developments that are profoundly disturbing. So, standing here today I would say we are looking at a mixed bag – or as I am prone to say, I am optimistic about possibilities but pessimistic about probabilities.
The sustainability imperative itself only arises because of the destruction we daily inflict on the planet. This destruction is a feature, not a bug, of the current economic model – call it growth capitalism – which as Paul Gilding has written, is built on “the delusion that we can have infinite quantitative economic growth, that we can keep having more and more stuff, on a finite planet.”
Historically, growth capitalism made no distinction between capital investments that destroy the environment, or worsen public health, or exacerbate economic inequality, and those that are aligned with earth’s natural systems or promote the general welfare. A dollar of output is a dollar of output; short-term profit is valued regardless of the long-term consequences or externalities. Addressing or ameliorating those externalities would fall to the public sector and to taxpayers.
The public sector’s appetite for intervention and regulation waxes and wanes, of course, depending in part on which political party or what governing philosophy is in power, and today, to the extent government has not become completely dysfunctional, it is more or less beholden to the industrial and economic elites who benefit from the current system and have outsized influence in shaping public policy to perpetuate that advantage. When I was in school, political scientists had a name for this – regulatory capture – where public sector regulators are essentially held captive by the very industries they are supposed to be regulating. Today, this phrase might strike us as almost quaint and naïve given what we have seen come to pass when it comes to the corrupting influence of money on politics and government.
There is also a stubborn, deep-seated resistance to changing this economic model, not only from the monied interests who profit by it, but from the public itself – consumers, investors, voters – who remain deeply wedded to this system, hard-wired to want “more and more stuff,” for a host of economic, social, psychological and even evolutionary reasons. We humans tend to be exceedingly short-term oriented, enthralled with material comforts, naively optimistic and fundamentally innumerate when it comes to the compounding mathematics that could eventually spell our doom if we don’t reverse course.
The good news, which should give us hope, is that public attitudes are rapidly changing. In the face of global challenges like climate change that our current economic model, and current economic and political elites, are clearly not addressing, there is a growing demand for a more sustainable form of capitalism. You have all seen the research about women and Millennials, but it is much broader than that. There is a rising demand for solutions.
The even better news is that, while capital markets and the financial services industry have existed to finance growth capitalism and thus, unwittingly in most instances, have also financed the destruction associated with it, this is changing too: we are currently in the process of pivoting away from growth capitalism to an alternative economic model.
This model, call it Sustainable Capitalism, may be thought of as an economic model where business corporations and capital markets alter their focus from maximizing short-term profit to maximizing long-term value, and long-term value expressly includes the societal benefits associated with or derived from economic activity. A more expansive notion of the business corporation takes shape where it begins to serve all of its stakeholders not just its shareholders, while capital markets begin expressly integrate ESG concerns. The connections between economic output and ecological and societal health are no longer obscured but are expressly linked.
At Impax, and at Pax World Funds, what we talk about when we talk about sustainable investing is precisely this: investing in this transition to a more sustainable global economy – from growth capitalism to sustainable capitalism, from a depletive economic model to a more circular, restorative economic model. We believe over the next decade or two this transition will present unique opportunities for well-positioned companies as well as risks for those unable or unwilling to adapt. There will be winners and there will losers in this transition. When we construct investment portfolios, we apply a Sustainability Lens to all 160 sub-sectors of the global economy, carefully examining these risks and opportunities and as we endeavor to parse out the winners from the losers.
Like most of you in this room today, we believe fundamental analysis that incorporates longer term risks and opportunities, including ESG factors, enhances investment decisions and helps us build more resilient and ultimately better performing investment portfolios.
But I would go further than that. I believe there is already, today, tremendous sustainability risk embedded in the market, and in investment strategies that fail to apply a Sustainability Lens to the market. Investment strategies that take the market at face value, as if it were somehow the efficient summation of all known wisdom, are succumbing to the short term, succumbing to current biases and conventional wisdom, and essentially investing in the Last Economy rather than the Next Economy.
Let me briefly touch upon two issues to illustrate this point: gender diversity and climate change. In one case, the Sustainability Lens we apply is very much a Gender Lens; in the other, it is fundamentally a Carbon Lens. In each case, we believe our Sustainability Lens helps us avoid risks embedded in the market and identify opportunities that only a long-term perspective, not a short-term term one, could decipher.
First, gender diversity. We know a lot about gender diverse leadership teams at this point. In fact, the research at this point is beyond compelling; it is overwhelming. Study after study after study all point in the same direction: Where women are better represented on company boards and in senior management, companies quite simply perform better. Full stop. Case closed.
At Impax and our Pax Ellevate division, we saw this research, and we asked ourselves the obvious question: If companies with more gender diverse leadership teams perform better, shouldn’t we be identifying those companies and investing in them? The answer was obvious, so we identified those companies by applying a Gender Lens to the market and constructed the first index in the world consisting of highest-rated companies in the world when it comes to having more women in leadership. We then invested in those companies through our Pax Ellevate Global Women’s Leadership Fund, whose investment thesis is simple: If the research is correct – if companies with more gender diverse leadership teams perform better – then there is an arbitrage opportunity to outperform the market by investing in companies with more gender diverse leadership and avoiding riskier, more homogeneous companies.
And, guess what? You guessed it: In the 5 + years since we build our women’s leadership index and launched the Pax Ellevate strategy, the fund has outperformed the market in the form of its MSCI World benchmark index – and in fact has not only outperformed over the 5-year time period but in every one of those five years.
While past performance does not guarantee future results, significantly, this outperformance has been accompanied by lower risk. The Fund has lower Beta than the MSCI World Index, lower Standard Deviation, better Downside Capture, better Sharpe Ratio, better Information Ratio.
Ordinarily – and this is Investing 101 – you take more risk in order to get better performance. Not so for investing in gender diverse leadership teams – the research would suggest, and our experience has been, that you can get better performance and lower risk at the same time.
And speaking of Investing 101, and risk, the first principle of investing, and of managing investment risk, is diversification. You don’t want to overweight stocks vs. bonds, or large caps vs. small caps, or value vs. growth, or domestic vs. foreign, or one sector, or one region vs. others, because if you do, you take on more risk, which could undermine performance.
Well then, with the research so clear – study after study indicating that gender diverse leadership teams deliver better results than homogeneous leadership teams – why would you want your investment portfolio overweight to men, and indeed to older white men? But that’s precisely what you do each time you invest in an S & P 500 index fund, or a Russell 1000 index fund, or what you would have done if you had invested in the MSCI World Index fund over the past 5 + years rather than in our Pax Ellevate fund, which has outperformed it.
By overweighting your portfolios toward men, you are ignoring all the research and everything we know about how and why gender diverse leadership teams provide better results. You are less diversified. You are buying into the gender risk embedded in the market. Applying a Gender Lens, by contrast, enables you to essentially put the diversity in diversification thereby mitigating that risk.
Let’s look briefly at climate change as well. Applying a Carbon Lens to the market to identify and clarify the longer-term risk and opportunities posed by climate change, is another strategy for mitigating the risk embedded in the market – effectively investing in the Next Economy rather than the last one.
As many in this room understand, there is now a range of identifiable risks associated with the failure to mitigate and adapt to climate change. Regulatory risk and the prospect of a price on carbon poses a particular set of risks for the fossil fuel industry. Physical risk – in a time of biblical storms, floods, fires and rising sea levels – can affect any company in any industry, and virtually any supply chain. Reputational risk can do serious damage to companies and brands that are viewed by consumers, investors and the public as part of the problem rather than part of the solution when it comes to climate change. Litigation risk will pose an increasing threat of damages and losses to companies that fail to take affirmative steps to address the increasingly foreseeable risks that climate change presents.
All of these climate risks are embedded in today’s market.
There are also opportunities for well-positioned companies to outperform the market over the longer term. The two fastest growing professions in the United States over the past 10 years were solar photovoltaic installers and wind turbine service technicians. Companies with business models built around energy efficiency solutions will constitute ever more attractive investment opportunities as we transition to a lower carbon future.
At Impax and Pax World Funds, we now offer eight fossil fuel free funds and we look at carbon risk across all our portfolios. In three of our funds, we apply a proprietary process called SmartCarbon™, developed by our colleagues in London in partnership with Carbon Tracker, to substitute energy efficiency stocks in place of fossil fuel holdings. This is because our investment process focuses on the transition to a more sustainable economy, and because or Sustainability Lens helps us uncover specific risks and opportunities associated with this transition.
Again, there is embedded climate risk in the S & P 500 or the Russell 1000 or MSCI World or ACWI. There is embedded gender risk. There is, more broadly, embedded ESG risk emanating from the fact that such indices do not apply a Sustainability Lens and do not integrate ESG factors into index construction. The market almost by definition reflects the biases of the Last Economy while failing to anticipate the risks and opportunities of the Next Economy. Investors can simply do better by applying a Sustainability Lens, and if we are going to transition to a more sustainable economy, investors will have to.
But that will not be enough – and this is where we are frankly up against it, and where my optimism about possibilities smashes dab up against my pessimism about probabilities. The public policy environment is as unfavorable as it has ever been, from abandoning the Paris accord, to rolling back auto fuel efficiency standards, to rolling back regulations on mercury, methane and God knows what else, to the SEC siding with the right wing of the business community in curtailing the voice of investors… the list goes on and on.
We will not be able to effectively transition to a more sustainable economy with government on the sidelines, or worse yet, actively opposing our efforts. Businesses and markets cannot do this work alone and won’t be properly incentivized to do this work without government as a fully engaged partner. Today this is clearly not the case.
I don’t know when we will be rid of the current crowd in Washington. I pray it is soon. But I do know this: when there is a change in administration, a change in which political party is in power, we need to be much better prepared than we were last time. When power shifts, we will need an agenda at the ready. We will need lawyers and lobbyists at the ready. We will need legislation at the ready. On climate. On shareholder access to the proxy ballot. On gender pay equity. On the silly political back-and-forth at the Department of Labor regarding ESG investments in ERISA plans: We should propose taking it out of DOL’s incompetent hands and have Congress legislate it once and for all. We should be proposing and advocating for public funding of political campaigns to get the corrupt stench of special interest money out of politics and government.
We should have legislation at the ready that not only gives preferences to investments in wind and solar and energy efficiency but to investments in low carbon mutual funds, ETFs, green infrastructure and other sustainable investments. Whether it’s a Green New Deal or some more incremental approach to climate change, we need to make sure there are adequate incentives for the private sector and capital markets to hasten the transition to a more sustainable economy.
We need to act like any other mature industry and petition government to shape markets in a way that in this instance would not only benefit our industry, but more importantly, would catalyze the transition to a more sustainable global economy.
The sustainable investing industry has led this historic pivot away from growth capitalism toward sustainable capitalism. But we would not have been able to do so had we remained a small niche investment strategy operating at the margins without the assets or the clout to move markets. Sustainable investing needed to penetrate the mainstream, to change the mainstream, to change the face of investing. This, I think, we are in the process of doing.
This is also why I have always believed that the mainstreaming of sustainable investing is so critical, though it of course brings with it a new set of challenges. The Business Roundtable should be applauded for embracing sustainable capitalism and a new, more expansive view of the business corporation’s duties to all its stakeholders not just its shareholders. But the voices of those stakeholders need to be heard, and today they are frequently heard through shareholder resolutions on sustainability issues that the SEC is in the process of curtailing, so the Business Roundtable needs to ask itself whether it can have it both ways. Companies whose marketing materials and web sites preach sustainability but then quietly lobby for lower fuel efficiency standards can’t have it both ways. Asset managers who embrace ESG but then vote their proxies against resolutions focused on advancing sustainability can’t have it both ways.
Sustainability isn’t just an asset gathering strategy, or a marketing ploy. We need to be an industry that insists on high standards, encourages dialogue, and collaboration, and transparency, and authenticity so we can manage through these growing pains as we convince more businesses, more asset owners, more financial professionals and more investors to embrace and participate in this vital transition.
Finally, economics was originally called political economy because it was understood that markets didn’t exist in a state of nature but were shaped by government to secure the common good, and political economy itself had its origins in 18th century moral philosophy. When we talk about sustainable investing we talk about risk and opportunity, as I have this morning, but the sustainability imperative is also fundamentally a moral concept, and has at its core a normative component, because it is ultimately about how we should best organize society to provide for the general welfare, for our fellow citizens and citizens across the globe, not only for our generation but for generations to come. Building the next economy is building the next society – hopefully one that is not only more sustainable, but more equitable and more just. This is important work. We need to go at it with a sense of urgency. We need to turn possibilities into probabilities so that my pessimism, and hopefully any you may harbor yourself, gives way to optimism. It’s a healthier way to live.
 Paul Gilding, The Great Disruption, Bloomsbury Press, 2011, p. 186.
 This notion of Sustainable Capitalism is not unlike the concept of “shared value” as advanced by Michael E. Porter and Mark E. Kramer. See, “Creating Shared Value,” Harvard Business Review, Jan-Feb 2011.
About Joe Keefe: Joe Keefe is President and CEO of Pax World Funds and President of its investment adviser, Impax Asset Management LLC, as well as CEO of its majority-owned subsidiary, Pax Ellevate Management LLC. Joe is a leading advocate for investing in women and the critical role that gender diversity plays in business success. Under Joe’s leadership, Pax has become one of the leading innovators in the rapidly growing field of sustainable investing.