The Mushrooming Scope of Sustainability Strategy

The stakes are rising because systemic risks have huge financial consequences

by Hal Hamilton

I’ll use ocean fisheries as a quick example of the scope of sustainability strategy.

Imagine that you and I each own fishing boats. Over the past few decades, we have evolved a system to regulate one another, and our competitors, to achieve a fair division of a “maximum sustainable catch.” Government agencies enforce the rules. Now, however, the context is shifting. Ocean temperatures are rising, water is becoming more acidic, and reef systems are dying. All these contextual changes mean that our target fish species aren’t reproducing as was expected. Some populations are collapsing, not from overfishing but from a change in the enabling conditions for species success.

Fishing is a metaphor for the larger economy. Sustainability strategy usually starts with a “materiality assessment” of impacts and an organization’s ability to have an influence on those impacts. In the example of fisheries, a relatively discrete set of players can agree on catch limits and their enforcement. As climate change affects the oceans, however, managing systemic risks is a bigger ballgame.

Large asset managers are among those in the business world who first noticed this shift, which has changed the parameters of reporting. Modern Portfolio Theory (MPT) had been the reigning framework for investment strategy since the 1950s, the essence of which is managing risk by building diverse portfolios.[1]  The values of specific stocks and bonds can go up and down while an overall portfolio is less volatile.

And now, two things have happened in parallel: systemic risks have grown, and investment managers are more concentrated. In the 1950s, when portfolio diversification was formalized, institutions owned 8% of the US equity market. Now it’s about 80%. Very large asset management firms “are increasingly likely to be universal owners, whose concern with portfolio companies’ externalities is likely to be at least partly because they understand that such externalities will affect the environmental, social, and financial systems on which the health of their overall portfolios rely.” (Just as the temperature and acidity of ocean water affects fish populations.)

Individual investors will still use index funds and diversified portfolios, which is reasonable, at least in the short-term. Overall, though, risk from climate and other “external” drivers is much greater than the idiosyncratic risk of specific equities in a portfolio. Financial and sustainability management of large companies is shifting from making choices about specific issues to confronting existential challenges.

Physical risks from climate change are already upon us, including rising temperatures and extreme weather events, but many businesses calculate these risks as slowly accruing over the coming decade. Our colleague Duncan Pollard, who helped write Nestle’s climate risk financial report, points out that transitional risks are even more immediate, and huge. Transitional risks include consumer concerns, stigmatization of sectors, re-pricing of assets, and abrupt policy shifts, especially carbon taxes, after periods of limited government action.

Nestle estimates that their enterprise value at risk, from 2021 to 2025, is between 5 and 9 billion dollars, or as much as 10 percent of the value of the company.

Lukomnik and Hawley write that, “Materiality is not a static concept but rather in a continual state of evolution.” For example, looking back over the last 150 years, slavery, child labor, a lack of labor health and safety standards, long hours of work, and discrimination all emerged as material, and solutions were eventually codified into law and regulation. Sometimes change happens very fast, and Lukomnik and Hawley call this “explosive materiality,” as happened with the onset of the COVID crisis.

“Traditional financial risk assessment focuses entirely on current monetary returns. But that return, like so much of the MPT tradition, is sealed away from reality. …the broader context in which future income flows.”

Financial officers may now be the most important allies of sustainability officers. Power has already been shifting from corporate management to financial markets, trending toward the influence of institutionalized asset managers who are more likely to factor-in systemic risk. “Power in a capitalist society depends on who controls the capital. …The new role of investors is to hold companies to account.” Value is becoming redefined within the context of the health of the larger economy.

The two largest asset managers each have trillions in assets under management. Norway’s sovereign wealth fund, for example, “…has nowhere to hide from market risk and therefore has adopted some aspects of universal owner thinking. …Investors increasingly understand the feedback loops between capital markets, the economy, and society as a whole.” Blackrock’s CEO wrote that “Climate change has become a defining factor in companies’ long-term prospects.”

The framework of “shared value” might be more and more accurate, and inescapable, if long-term private value can only be created when aligned with public value.

Although a capitalist economy’s competition for value and efficiency generates many desirable results, even Milton Friedman argued that profit-seeing markets work “so long as they stay within the rules of the game.” I would add “norms” to rules, and I’d frame the aspiration a little differently: we want markets to not only “work” but also survive. And survival will require a shared aspiration to live within natural limits. We can’t forever consume non-renewable resources at a rate faster than they are replaced with renewable resources, and we can’t continue to pollute the air, water, and land. These are not only nice but also necessary goals.

The good news is that financial markets may stimulate their incorporation into business practices and laws. I realize that this might be read as naively optimistic, but we might also see the goal of living within natural limits as urgently realistic.


[1] The following paragraphs draw from a book, Moving Beyond Modern Portfolio Theory, Investing that Matters, by Jon Lukomnik and James Hawley. All quotes below are from this book. (My friend and mentor Duncan Pollard recommended it.)

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