September 3, 2025 • 38 mins
Modern portfolio theory tells us that company-specific risks can be reduced through the magic of diversification. But what about market-wide risks, like climate change and income inequality? On this week’s episode of the ESG Currents podcast, BI Senior ESG Analyst Rob Du Boff speaks with Jon Lukomnik, managing partner of Sinclair Capital and a pioneer in corporate governance. They discuss how shareholders can use ESG analysis and corporate engagement to minimize systematic risks that threaten all investments. This episode was recorded on July 31.
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Speaker 1 (00:09):
ESG is constantly evolving over the years that has shifted
from socially responsible investing to impact to sustainable finance, with
terminology changing once again. What is not changing are the
underlying science, market pressures, and tangible physical and financial impacts
from the climate crisis, regulatory pressures and consumer expectations. We
(00:31):
aim to filter out the noise by speaking with industry
experts to identify what is really driving value. Welcome to
ESG Currents, your guide to navigating the evolving ESG space,
one topic at a time. Brought to you by Bloomberg Intelligence,
part of Bloomberg's research department, with five hundred analysts and
strategists working across all major world markets. Our coverage includes
(00:53):
over two thousand equities and credits, as well as outlooks
on more than ninety industries and one hundred market indices,
currencies and commodities. I'm Rob Diboff, Senior ESG analyst for
Bloomberg Intelligence. Modern portfolio theory tells us that investment risk
can be significantly reduced through the magic of diversification. Idiosyncratic
or company specific risks are minimized and one is left
(01:15):
with systematic risk. But can we reduce that systematic risk,
and if so, do money managers, as stewards of client capital,
have an obligation to do just that. Today's guest on ESG. Currents,
is one of the pioneers of modern corporate governance. John Leacomick.
John is managing partner of Sinclair Capital, ADJUDGT, Professor at
(01:36):
Columbia University School of International and Public Affairs, and former
Deputy Comptroller for the City of New York. Thanks for
joining us today.
Speaker 2 (01:43):
It's my pleasure, Rob, Thanks for inviting me.
Speaker 1 (01:45):
So I know my intro did not do enough justice
to your bio and your impact on the field of
corporate governance. So can you tell us a bit more
about your career journey. Why is it that corporate governance
is so important to you?
Speaker 2 (01:58):
It's not just corporate governance is now does one offset
real world liabilities through investing? Here's what I mean by that.
You mentioned I was Deputy control of the City of
New York. What I did in that position was I
was in charge of the investments for the five New
York City pension funds. In the mid nineteen nineties, zero
(02:18):
were about eighty billion dollars and now closer to three
hundred billion dollars, and you are charged literally with the
retirement security of eight hundred thousand ex New York City
workers at some point in their lives. As you might
imagine that as a crazy busy job, you actually have
five boards you have to report to. You're investing in
(02:40):
various asset classes, your modetory managers. By the way, I
was always in charge of investing the city's own cash
and cash flow, which is a bit tricky because it
varied by billions of dollars on any one day. And
one day I'm sitting there, I had a couple of cancelations.
I actually had time to think, and I'm looking out
over the trading desk and realizing that everything I knew
(03:06):
was a word that I can't say on the air
for you, but I'll say nonsense, because what I really
needed was someplace to put eighty billion dollars to a
real rate of return above the rate of inflation forever.
Now technically it's above your super liability rate. It's good
enough above the rate of a real inflation rate forever.
(03:28):
And modern portfolio theory just gives you no guidance whatsoever
to do that, because it's all based on relative return. Right,
you try to beat a benchmark, you're trying to compare
yourself to beta the market return. And that started this
journey not just in corporate governance, but now to systems
(03:51):
level investing of so, how do you do this? How
do you actually invest to offset billions or tens of
billions of dollars in real world liabilities? And that's why
it matters to me, because it's not just a game
of beating a benchmark. It's how do you help people,
(04:15):
say for retirement or college, or the necessities of life
or buy a house.
Speaker 1 (04:21):
Yeah. No, that's a lot of responsibility there. So let's
dive in a little bit on systems level investing. What
is it? How does it differ from maybe traditional theories
of financial markets.
Speaker 2 (04:33):
It's all about risk and return. As you said, Mouti
portfolio theory brilliant Harry Markowitz nineteen fifty two. Invention that said,
don't worry so much about the safety of an individual stocks.
It's what happens to the portfolio overall that matters. And
you can diversify and mitigate the idiosyocratic risk, as you said,
(04:54):
I want to stop them and give that theory it's due.
It was a revolution right before that. Like you know,
people just invested in US government bonds and actually railroad
bonds because they were considered safe at the time and
stocks were just considered risky. It gave birth. It really
accelerated the entire thing of in equity culture in this country.
(05:14):
It also turbino charged the market for prepackaged diversification ETFs,
index funds, mutual funds, hedge funds, whatever you want to think.
I mean, very few at that time people invested buying
an individual stock, if they bought stocks at all, looking
at stock table on the newspaper. Here's the problem with MPT.
We know from later studies Brinson, Beerboo Hood, various Roger
(05:38):
Ibittsen studies that in fact, security selection, the stuff you
can diversify away from, accounts for six to twenty five
percent of your total variance in return, systematic risk, as
you mentioned, non diversifiable risk, the general price level of
the markets actually accounts to seventy five to ninety four
(05:59):
percent of each. And so the problem with traditional investing
is that it focuses you on what matters least. Now
I'm not minimizing it at all. It is a great
tool to extract the best possible risk return portfolio from
the extent market, but it doesn't deal with that seventy
five to ninety four percent. System level investing tries to
(06:22):
deal with that seventy five to ninety four percent of
total variance of return by saying, what are the market dynamics?
What is the market depend on? And I will make
this short because I'm sure you have a follow up question.
I've been speaking for a long time. You know, markets
(06:43):
depend on the economy, healthy capital markets to translate the
risk and return of the economy to investable opportunities. What
is the economy rely on? When you break it down,
it relies on healthy environmental, social, and financial system And
so in theory, if you can mitigate the risk to
(07:04):
those systems, the economy should do better, Your capital markets
should be able to translate that, and your portfolio should
be able to do better.
Speaker 1 (07:12):
So the focus is less on you know, alpha, which
we always hear about it, more just how do we
get the most bang for the beta?
Speaker 2 (07:18):
Is that right? I mean? Or as we say always said,
the fact that beta is silent doesn't mean it's not salient, right, right?
Speaker 1 (07:25):
You know, and as you say it's almost ninety percent,
could be up to ninety.
Speaker 2 (07:29):
Right, you know. And the problem is all the academic
theories that grew up around MPT assumed that beta was exogynous, right,
I mean I used to want to call this theory
in seat of system. Well, we call it better beta.
And all the finance professors got agree with you. No,
beta's one point zero. It's always one point zero. And
(07:51):
I so said, yeah, but what one point zero is
in twenty twenty five is different than what it was
in twenty twenty one. You know, they are abouto total upmarkets,
they're a montotal deal markets, and you're telling me it's
always one point zero. Again, let me go back to
my revelation running the City of New York. If I
have a down ten percent market and I'm only down eight,
(08:12):
I've done a great job and I've outperformed by two
hundred basis points. Right, but I soil only have ninety
two cents to upset my liabilities. Yeah. Right, If the
market's up ten and I'm only up eight, I've done
a horrible job of underperformed by t to hundred basis points,
but I've got a dollar eight to pay the pensions,
which is better what measures my skill, but the other
actually measures is the function I'm trying to do. And
(08:34):
so system level of investing tries to focus on the
function and how do you improve beta, shift the whole
market up into the left in investments speak, which means
less volatility, more return, and then apply MPT atop a
better opportunity set.
Speaker 1 (08:51):
Yeah, so I would, I mean, certainly, I would suspect
the reason why beta is so solid is because you know,
there's almost this FATA company to it where it's you know,
beta is what the it is. So you're saying that,
you know there are things that can be done to
do that, so you know, you know, when I was
in business school, it was always you know, it was
systematic risk was often referenced to as non diversifiable risk,
(09:14):
the implication meaning that you can reduce financial risks through diversification,
but at the end of the day, there's just some
risks you can't avoid. But you're saying that's not necessarily true.
Speaker 2 (09:23):
Well, I actulutely agree it's non diversifiable. That doesn't mean
it's not nonmitigable, right, And the problem is we've all
focused no offense to mister Blueberg got Bloomberg trading terminals, right,
that's where you invest. You move assets around to reduce
climate change, antimicrobi resistance risk risks across an entire industry,
(09:50):
like the repeated collapses of tailing dams in mining, you
actually have to go into the real world. And so
the difference is for MPT based investors, you tried to
diversify idiosyncratic risk, and the field you're playing in is
capital markets. For systems level investing, it's all that, but
you're also trying to reduce systemic risk. Let me justify that,
(10:11):
which is risk to the systems that results in the
systematic or non diversifiable risk in the capital markets. But
to do that you have to went to the real world.
And that's not something that investors had for the last well,
well that public equity investors have for the last fifty
seventy five years been comfortable with. Private market investors do
(10:33):
it all the time, right, right, But so in some
ways this is a return to the way investing used
to be before MPT said let's focus on idiosyncratic risk.
Speaker 1 (10:47):
So now you're speaking the language of ESG currents. That's
it's not about you know, let's do this because it's
the right thing to do.
Speaker 2 (10:53):
We love hugging.
Speaker 1 (10:54):
The trade is this is a way to enhance your
returns to help obligations. Not that doing the right thing
is something to be spoken down on to, but just
that this is all about financial returns and how do
we enhance returns, especially in the face of having an
obligation to pensioners and other clients.
Speaker 2 (11:14):
You know, I co teach at Columbia with my fellow
professor Bill Burkhart. My book movie Beyond Modern Portfolio Theory,
which I wrote with Jim Hawley, came out same time
Bill's book Twenty first Century Investing came out. He co
WROTD with Steve Leidenberg, and I always tell the students
in the first class, I'm really boring. All I want
(11:36):
is a better risk return profile for my portfolio. Right
Bill is great. Bill comes from the impact side of
the world, and he wants to save the world. And
the interesting thing is that we both converge on the
importance of systems. We also both realize you're doing ESG courage.
(11:57):
You know how term get messed up and thrown around
and demonized if system level of investing gets associated with Oh,
it's just another word for quote ESG or climate. It's woke, right,
And I don't know necessarily think there's anything wrong with
being woke, but the way it's been demonized, that will
(12:19):
be the death knell of it, right, because it is
about risk and return. It's about improving what beta represents
and then allowing MPT to do its magic above it.
Speaker 1 (12:31):
So what does this look like in practice? What are
some of the effective tools of system level investing? Are
there some examples you can share?
Speaker 2 (12:37):
Sure? The most common is systemic stewardship, And so you know,
traditional engagement or stewardship with a company is what Elliott
might do or Carl Khan or Bill Ackman. You have
an underperforming company and you try and turn around the company, right,
and let's call that alpha stewartge right, You're dealing with
(13:01):
the enterprise value of individual company. Systemic stewardship says, what's
the issue? So let me not take climate change because
everyone takes it, and just take I think that affects
a broad swath. If you're going to invest in mining,
and your Apple iPhone and everyone's everything nowadays has rare
(13:23):
earth materials and other things in it, so we have
to have minding if we're going to decarbonize. It's needed
for electrification. But it turns out that there were minding disasters,
you know, every few months, the most famous one being
one in Brazil where when you mine all the stuff
(13:43):
you don't want, you have to throw away somewhere right
the tailings, and in this case it was liquid. It's
a tailing dab holding a tailing pond and it collapsed
killed two hundred and fifty four people. At first, the
Swedish pension funds and the Church of England pension fund
commissioners started talking to Valet, which was the owner of
(14:05):
this damn about you know, you got to do better.
They soon realized that this actually was a systemic risk
because there was sort of a race to the bottom.
The cheapest way to build the tailing dam was also
the one that was going to collapse the most often,
and no one knew where they were. And so they
worked with the industry to set up standards for tailing dams,
(14:29):
called the Investor and Industry Tailing and Mining Initiative. And
they first thing they had to do is find out
how many of these dams there were, because they often
are in remote regions that you know, I live in
New York. I mean, let's be honest. We have a
you know, I didn't know where this place in Brazil was, right,
(14:49):
And so they mapped eighteen hundred of them. They got
the industry to agree, they brought in a couple of governments,
they brought in the UN, and now there standards for
tailing them. So that's what I mean by how you
go systemic stewardship. They weren't dealing with valet, they were
dealing with the problem, right.
Speaker 1 (15:09):
That makes a lot of sense. So have corporations on
their boards been receptive to this worldview?
Speaker 2 (15:17):
Some have, some haven't, often a lot of when there's
something that's sectoral, and it also depends on jurisdiction. Obviously
Europe is much more accommodating than some parts of the US,
although parts of the US are US. And let's deal
with the corporate side of the investor side, because I
(15:38):
mostly deal with the investor side. So the binding Itaian
initiative is an example where the corporation's joined forces. Similarly,
antibicrobial resistance is where you breed super antibatic resistant bacteria
are is scheduled to cost millions of lives and hundreds
(16:02):
of billions of dollars in the next ten years. Nordea
Bank went and found that one of the biggest contributes
that was the strip of pharmaceutical company manufacturing sites in
India where they manufacture generic antibiotics. There was a lot
of groundwater affluid and that in fact created the perfect
(16:25):
breeding grounds for superbugs. And they worked with those manufacturing
plants and with the Indian government and that's basically a
solve problem there right now, there's overuse in various other places,
and so often the place that I find or the
condition I find industry to be most accommodating is where
(16:48):
they know there's a race to the bottom to externalize costs.
And most CEOs or boards don't want to wake up
in the morning and think they're doing something nasty. They
just don't want to competiti to be able to externalize
the class to them not. So if you can set
a standard, which is another tool of system investing that
(17:09):
you can get buy in, you can actually have everyone
on a level playing field. That's when I find the
corporate side to do the most. The investing side is
really interesting. Asset owners, especially big woods have picked up
(17:29):
on this. I mean, and it's not new. Norgest Bank
in twenty twelve said there were universal owners and so
why would we do something we owe a slice of
the economy. Why would we do something in one part
of our portfolio that damaged another part. GPIF in Japan,
the largest pension play in the world, said the same
(17:50):
thing in twenty seventeen. And now you've got places like PGGM,
the Dutch pension giant, changing their entire philosophy for what
they call two D risk and return to three D
risk and return and impact. You've got cal STIRS in
the US doing systemic stewardship. University Pension Plan of Ontario
(18:12):
in their investment belief statements draws out why they believe
they need to reduce systemic risk in order to have
long term sustainable capital markets HESTA and Australia. So the
asset owner side, the really large universal owners, it has
a fair amount of pickup. Now, I don't want to
(18:33):
exaggerate this either, right, and I will just mention that
some asset managers BNP, POWERBA, Legal and General will also
have aspects of this. I don't want to exaggerate it.
Last time, I looked, there was three to five trillion
dollars sort of in what I would call a journey
towards system level investing. There's one hundred and fifty to
(18:54):
two hundred trillion yeah, out there right. So on the
one hand, you know, three to five live trullion is
a lot. On the other hand, it's a minute portion.
But our books came out in twenty twenty one, so
it's four years since the books came out. We've been
talking about it and writing papers for ten years. I
(19:15):
would tell you that modern portfolio theory didn't catch on
until the nineteen eighties. It was written in nineteen fifty two. Wow.
In fact, until nineteen ninety nine, the state of Indiana
prohibited its pension fund from investing inequities. So, you know,
things change slowly. And I am very pleased at the
progress and the attention in academia and in the consulting field,
(19:42):
the people consult to large asset owners and in asset
management and asset ownership that it's getting. So, you know,
I want to give you real numbers. I don't want
to say, oh, yeah, everyone's doing this. They're not, but
enough are and and many of them are real thought
leaders in the field, like PGGM, like People's Pitch, and
(20:06):
FUD of the UK, like UPP in Canada, like Calsters.
Speaker 1 (20:11):
So the biggest pushback I hear on this. And while
asset owners and some of the big portfolio managers, you know,
they're interested about their whole portfolio, their universal owners. They
want to minimize risk across their full portfolio. But you
know the pushback I hear is the management and the
board of each individual company. They still have a fiduciary
duty to maximize the risk return profile of their own company.
(20:33):
So how do you deal with that tension between you know,
maybe optimizing system wide outcomes versus maximizing risk return of
an individual security.
Speaker 2 (20:43):
Let me first give you a caveat that is true
in the United States. That is not necessarily true in
Europe or Japan or elsewhere, but you correctly state the
situation in the US. The question is a balancing act.
What can you do that? First off, they're windwinds, right,
(21:07):
but those are easy to discuss, So you know, wow,
that's great. You know, Coca cola needs clean water. Let's
make sure we have clean water. Okay, But there are
cases in which you can boost your enterprise value by
externalizing costs, no doubt about it. The question becomes one
(21:28):
over time what is material right? And materiality is not
a fixed set of things. I often ask my kids
if they know what a major source of loans in
the London interbank loan market was in the early nineteenth century,
and no one guesses what it was, which was the
lives of American slaves. Wow. Yeah, I mean it's sort
(21:50):
of shocking. But if you think it's eighteen twenty, right, yeah.
And so what happens when an individual company or enterprise
acts in a way that is out of alignment with
(22:11):
what society thinks it should do. The societal license to
operate concept? Sometimes nothing, let's be real. But sometimes first
there's reputational risk. I will tell you that if you
work for a tobacco company, they will admit that they
have to pay more to hire people. So sometimes there
are cost issues. Over time, there could be regulatory risk,
(22:34):
and over time, as in slavery, it can become illegal.
Now that's obviously a dramatic example, I mean, but it
does illustrate what happens, and you you can see it
now even with coal, I mean, coal has rereaded it's
(23:00):
you know, the cheapest electrical on a life cycle basis
is solar. And so you see entire countries, including many
Middle East countries where they have tons of oil, right,
they're building solar right right, because the economics of it.
When something is out of step with society, people throw
(23:21):
money at it to find a solution. That's one of
the other tools of intentionality as we call it, which
is you find the systemic opportunity and you try to
do it. So again, things are never all or nothing.
There will be sub companies that can successfully externalize cost
for a long time and no one will notice or care.
(23:42):
Maybe they're not important. There are sub companies that will
be caught tomorrow, and there are other companies that are
somewhere in the middle. And it will also depend on
the jurisdiction you're in and with the societal expectations of
the jurisdiction are.
Speaker 1 (23:56):
And certainly there's a component of time horizon as well.
I mean, you know, the Middle East country may maybe
in their best interest to milk the oil fields today,
but then reinvest those profits into.
Speaker 2 (24:08):
Well, except they're building you know, they're all their sovereign
wealth funds to try to diversify themselves away from oil
because they understand it. Also, I want to talk about
time horizon for a second. I find time horizon fascinating.
I've looked at functional MRIs of temporal decision making and
everything else, but I want deal specifically one thing. I
(24:29):
do think that the sustainable investment can be sometimes get sloppy.
It says, well, it's a long term risk. And what
people not in the community here when they hear that
is you can't prove it. Therefore you say it's long
term and you know no one can disprove it, and
blah blah blah blah. So when it comes to climate change,
for instance, it's not long term anymore. You know, we
(24:49):
get wild would a simple example, wildfires are Los Angeles, Okay,
affects the municipal bond market, affects the real estate market,
affects some economic output, and people go, well, that's okay,
I'm not on the West Ages. Really still think called
the reinsurance market. All reinsurance rates went up. That was
a cost to the world, cause or accelerated by climate change.
(25:16):
So you start to see the impacts of systemic risks,
now not long term.
Speaker 1 (25:24):
That makes a lot of sense. Especially you know with
some of the things like oil fields and oil pipelines,
there are such a long term planning that you have
to do that you really have to think about the
lifetime of the project, not just what's my.
Speaker 2 (25:38):
So of the better systems thinkers in the world or
Cabridge University. I have to thank Bloomberg for this. They
have developed a new Boded Dicks. Do you know about this, Ah, well,
you're about to hear about it. It's it's it's the
beecam Investment Grade Boded Dicks and is being rolled out
(26:00):
I Bloomberg Q three. And what they have done is
you could be a fossil fuel company and you're still
in the index. But the purpose of the BOD cannot
be to expand the fossil fuel footprint, as you say,
over time. So you can't build a new liquefied gas terminal,
(26:21):
you can't develop a new field or build a pipeline.
And the idea is to direct capital away from those
things which will memorialize or institute twenty or thirty years
more of fossil fuel. So it's actually a very intelligent
use by people who are the University of Cambridge self
(26:45):
identifies as a system level investor. Doctor Ellen quickly helped
develop a lot of the philosophic framework for this. And
they're also very smart because while we talk about stewardship
often in the public equity market, that's a secondary trading market.
The capital doesn't really go to the companies. There's a
(27:06):
very minor effect, whereas fixed income bonds are primary issuance.
And so to the extent that this orient's capital away
not from someone who's fossil fuel company, They've been doing
it for years. They try to figure out how to transform,
(27:27):
but to people who to companies which are saying, no,
we want to lock in the use of fossil fuels
for next twenty or thirty years. It's a very intelligent,
in my mind, constructed index. So coming Q three to
your bluebird TRIBERL.
Speaker 1 (27:40):
Yeah, for the record, we this is not a paid
endorse It.
Speaker 2 (27:42):
Was not a paid endorsement, but I mentioned it because
I think it's actually one of the more clever and
potentially impactful things that a system level investor has done,
which is try to set a standard through an index creation.
Speaker 1 (28:00):
I mean, so I have an oil and gas background,
you know, covering that industry, and it always you know,
it seems to be it's not a black and white
issue of you know, there are some projects you can
certainly invest in that, you know, maybe not ideal today,
but for the world's given constraints, may make sense. But
there's other investments that, as you say, lock us in
for twenty to thirty years.
Speaker 2 (28:18):
Look, we clearly don't have the ability to electrify without
oil and guests. And we're recording this on a Wednesday
on Thursday, right, not going to happen, and the idea
that it will is wishful thinking, I think some people,
(28:39):
And so I think this is a very intelligent way
to say, let's try to drive capital to solutions without
impeding the day to day life of the world.
Speaker 1 (28:53):
So, speaking of the day to day life of the world,
the current administration has already taken a number of measures
to limit the rights of shareholders to weigh in on
corporate decisions. On top of that, you have a corporate
governance race to the bottom, with several states watering down
regulations to attract companies to reincorporate. I assume you have
an opinion on US.
Speaker 2 (29:12):
It's interesting. I think Bob Monks, one of the pioneers
of corporate governance, has recently died and was a Reagan
administration Department of Labor official. Said capitalism without owners will fail.
What does that mean? What does that mean? It means
that in a capitalist society, those who provide the capital
(29:35):
have the right, but also the obligation, to suggest what
the highest and best use of that capital is. We
are I think if there is a corporate governance philosophy
of the current administration is what I would call corpocrisy,
(29:56):
right you want, they try to empower corporate managers, not
necessarily the owners. So you see Texas doing things to
attract Elon Musk. You see the sec making it harder
(30:20):
for owners to put forth proxy resolutions. I think it's shortsighted.
I will tell you a story that indicates how short
sight it is. As you know, in Texas they also
have this blacklist I don't know what to call it of.
(30:44):
You know, don't invest with companies who have been thought
to quote boycott end quote fossil fuel companies for a
long time. Black rockers on that list. At one point,
a land trust in Texas wrote the Attorney General and said,
we have this private equity portfolio and it has blackrock.
(31:07):
What should we do? And he said, well, technically private
equity isn't covered by the law, but it's blackrock, so
if you can trade it in the secondary market, get
out of it. You know what that private equity fund was.
There's oil and gas pipelines, right, and so we have
reached I mean, I'm just going to call it for
what I think it is. That is a socialist phenomenon,
(31:28):
not a capitalist one, where government favors or disfavors certain
industries and then ultimately decides to favor or disfavor individual
companies like Blackrock or you know, or someplace else. And
you know, we tried that, or we didn't try it.
The Soviet Union tried it. It didn't work so well.
(31:52):
And so if you're going to have capitalism, you have
to empower owners to feel that they have some oversight
over their capital. There are very few people who I
would trust when they come to me and say give
me some money. I'm not going to tell you what
(32:12):
you're going to do. I'm not going to report on it.
I'm not going to write. And yes that's overstating where
Texas is going. But the rights are being limited and
at some point it just doesn't become an attractive place
to put capital, not immediately. You know, the most efficient
(32:33):
form of government is a dictatorship, but it's not necessarily
one that has proved sustainable over time. And so if
you're going to create a form of economic organization where
you empower corporate managers over the providers of capital, that's
(32:54):
no longer capitalism.
Speaker 1 (32:55):
That's very true. And in terms of the asset owners
that are I mean, you mentioned quite a few looking
at system level investing, but is there kind of a
chilling effect going on?
Speaker 2 (33:05):
I mean, obviously, oh, there's a huge chilling effect. I mean, look,
one of the other things that people are talking about
in Washington is regulating proxy advisors. For those of you
who don't know, proxy advisors suggest to asset owners or
asset managures how they should vote on various issues, including
who should be on a board or or if there's
a request for a report on something that the company
(33:27):
from how they impact climate change or greenhouse gas emissions
or whatever. And a number of the Business Roundtable the
Chamber of Commerce have made it very clear they do
not like the current situation where there are two dominant
proxy advisors because some four percent of recommendations are against management.
(33:49):
And you know, say on pay has been a flashpoint
because they're often against management on executive compensation. I wouldn't
like having people voting about compensation either, but if I'm
taking their money, you know, that's sort of the trade.
In reality. I don't believe they have the votes in
(34:13):
the current Congress with the slim majority of the House,
to pass proxy advisory regulation, and the SEC just lost.
I tried to regulate proxy advisors in the DC courts,
so they can't just do it unilaterally. They need legislation.
That doesn't mean that they can't hold hearings, that they
(34:36):
can't make document demands, that attorney generals who are of
a particular political bid can't write to asset owners or
asset managers in other states, and that does have a
chilling effect. And I think the people who would like
(34:56):
to regulate proxy advisors understand that and regard it a
is a win. I am aware, for instance, of one
on ESG, generally one trillion dollar US based asset manager
who got a letter from seventeen red state attorney generals,
a cost of a million dollars in legal fees and
(35:17):
document production and everything, and they had two years before
hired a very prominent stewardship team and they have let
them all go. You know, I don't think it is
affecting the asset owners who are fort the sort an
economic basis. I do think it is affecting asset managers
who thought this was a way to gather assets. And
(35:39):
quite honestly, every you know, they were allies as well.
And so you know, there are people who say, oh,
that's great, we now have only people who truly believe,
and I'm seeing them going, excuse me, and economics, I'd
like another trillion dollars on my side, please. You know,
so it does have a chilling effect. I'd be foolish
(36:01):
to say it doesn't.
Speaker 1 (36:03):
All right, last word here, So imagine lis scenario you're
called to Congress. They're thinking about, as they are currently doing,
regulating the pension fund law ARISA around what canon can't
be considered. They're saying, you know, we don't want this
woke stuff. We don't we should only focus on profits.
What do you say to that?
Speaker 2 (36:23):
Every What I would say is every law that has
been passed through a red state about this has a
fiduciary out and by the way, it's not just on
the left on the right, it's on the left as well.
Our gun just passed the law mandating the vestiture. I
think that's equally silly because if you are going to
say you start with an economic analysis that fits into
(36:47):
your fiduciary obligation, then you should let people do that.
There there is a lack of tolerance and people are saying,
I know what fits right, and it's pure politics on
their point, whether from the left to the right. So
as I said, our God did that. On the right,
(37:08):
you know, the US federal thrift savings word isn't allowed
to invest in China. Now you want to tell me
you know that's an ESG political decision, if you will.
There was no economic analysis and what it does to
the ability to track it, index or do anything else.
And the problem on both the left and the right
(37:28):
is they make the same mistake. They start. The right
says you shouldn't be dealing with issues like climate change,
and the left says you're not doing enough to deal
with issues like climate change. And they're both making the
same mistake, which is they are looking at that issue
instead of the economic impact on the portfolio. That universal
(37:50):
orders look at and try to adopt and therefore go
to system level investing to improve. As you said, it
all comes around to risk and return.
Speaker 1 (37:59):
Great, John, thanks so much for your time and for
our listeners. You can find more information on sustainability issues
on bispace ESG go on the Bloomberg terminal. If you
have an ESG quandary you would like to ask bi's
expert analysts or learn more about our research, send us
an email at ESG Currents at bloomberg dot net. And
if you like this episode, please subscribe on Apple, Spotify,
(38:21):
or your favorite podcast platform
ESG is constantly evolving over the years that has shifted
from socially responsible investing to impact to sustainable finance, with
terminology changing once again. What is not changing are the
underlying science, market pressures, and tangible physical and financial impacts
from the climate crisis, regulatory pressures and consumer expectations. We
(00:31):
aim to filter out the noise by speaking with industry
experts to identify what is really driving value. Welcome to
ESG Currents, your guide to navigating the evolving ESG space,
one topic at a time. Brought to you by Bloomberg Intelligence,
part of Bloomberg's research department, with five hundred analysts and
strategists working across all major world markets. Our coverage includes
(00:53):
over two thousand equities and credits, as well as outlooks
on more than ninety industries and one hundred market indices,
currencies and commodities. I'm Rob Diboff, Senior ESG analyst for
Bloomberg Intelligence. Modern portfolio theory tells us that investment risk
can be significantly reduced through the magic of diversification. Idiosyncratic
or company specific risks are minimized and one is left
(01:15):
with systematic risk. But can we reduce that systematic risk,
and if so, do money managers, as stewards of client capital,
have an obligation to do just that. Today's guest on ESG. Currents,
is one of the pioneers of modern corporate governance. John Leacomick.
John is managing partner of Sinclair Capital, ADJUDGT, Professor at
(01:36):
Columbia University School of International and Public Affairs, and former
Deputy Comptroller for the City of New York. Thanks for
joining us today.
Speaker 2 (01:43):
It's my pleasure, Rob, Thanks for inviting me.
Speaker 1 (01:45):
So I know my intro did not do enough justice
to your bio and your impact on the field of
corporate governance. So can you tell us a bit more
about your career journey. Why is it that corporate governance
is so important to you?
Speaker 2 (01:58):
It's not just corporate governance is now does one offset
real world liabilities through investing? Here's what I mean by that.
You mentioned I was Deputy control of the City of
New York. What I did in that position was I
was in charge of the investments for the five New
York City pension funds. In the mid nineteen nineties, zero
(02:18):
were about eighty billion dollars and now closer to three
hundred billion dollars, and you are charged literally with the
retirement security of eight hundred thousand ex New York City
workers at some point in their lives. As you might
imagine that as a crazy busy job, you actually have
five boards you have to report to. You're investing in
(02:40):
various asset classes, your modetory managers. By the way, I
was always in charge of investing the city's own cash
and cash flow, which is a bit tricky because it
varied by billions of dollars on any one day. And
one day I'm sitting there, I had a couple of cancelations.
I actually had time to think, and I'm looking out
over the trading desk and realizing that everything I knew
(03:06):
was a word that I can't say on the air
for you, but I'll say nonsense, because what I really
needed was someplace to put eighty billion dollars to a
real rate of return above the rate of inflation forever.
Now technically it's above your super liability rate. It's good
enough above the rate of a real inflation rate forever.
(03:28):
And modern portfolio theory just gives you no guidance whatsoever
to do that, because it's all based on relative return. Right,
you try to beat a benchmark, you're trying to compare
yourself to beta the market return. And that started this
journey not just in corporate governance, but now to systems
(03:51):
level investing of so, how do you do this? How
do you actually invest to offset billions or tens of
billions of dollars in real world liabilities? And that's why
it matters to me, because it's not just a game
of beating a benchmark. It's how do you help people,
(04:15):
say for retirement or college, or the necessities of life
or buy a house.
Speaker 1 (04:21):
Yeah. No, that's a lot of responsibility there. So let's
dive in a little bit on systems level investing. What
is it? How does it differ from maybe traditional theories
of financial markets.
Speaker 2 (04:33):
It's all about risk and return. As you said, Mouti
portfolio theory brilliant Harry Markowitz nineteen fifty two. Invention that said,
don't worry so much about the safety of an individual stocks.
It's what happens to the portfolio overall that matters. And
you can diversify and mitigate the idiosyocratic risk, as you said,
(04:54):
I want to stop them and give that theory it's due.
It was a revolution right before that. Like you know,
people just invested in US government bonds and actually railroad
bonds because they were considered safe at the time and
stocks were just considered risky. It gave birth. It really
accelerated the entire thing of in equity culture in this country.
(05:14):
It also turbino charged the market for prepackaged diversification ETFs,
index funds, mutual funds, hedge funds, whatever you want to think.
I mean, very few at that time people invested buying
an individual stock, if they bought stocks at all, looking
at stock table on the newspaper. Here's the problem with MPT.
We know from later studies Brinson, Beerboo Hood, various Roger
(05:38):
Ibittsen studies that in fact, security selection, the stuff you
can diversify away from, accounts for six to twenty five
percent of your total variance in return, systematic risk, as
you mentioned, non diversifiable risk, the general price level of
the markets actually accounts to seventy five to ninety four
(05:59):
percent of each. And so the problem with traditional investing
is that it focuses you on what matters least. Now
I'm not minimizing it at all. It is a great
tool to extract the best possible risk return portfolio from
the extent market, but it doesn't deal with that seventy
five to ninety four percent. System level investing tries to
(06:22):
deal with that seventy five to ninety four percent of
total variance of return by saying, what are the market dynamics?
What is the market depend on? And I will make
this short because I'm sure you have a follow up question.
I've been speaking for a long time. You know, markets
(06:43):
depend on the economy, healthy capital markets to translate the
risk and return of the economy to investable opportunities. What
is the economy rely on? When you break it down,
it relies on healthy environmental, social, and financial system And
so in theory, if you can mitigate the risk to
(07:04):
those systems, the economy should do better, Your capital markets
should be able to translate that, and your portfolio should
be able to do better.
Speaker 1 (07:12):
So the focus is less on you know, alpha, which
we always hear about it, more just how do we
get the most bang for the beta?
Speaker 2 (07:18):
Is that right? I mean? Or as we say always said,
the fact that beta is silent doesn't mean it's not salient, right, right?
Speaker 1 (07:25):
You know, and as you say it's almost ninety percent,
could be up to ninety.
Speaker 2 (07:29):
Right, you know. And the problem is all the academic
theories that grew up around MPT assumed that beta was exogynous, right,
I mean I used to want to call this theory
in seat of system. Well, we call it better beta.
And all the finance professors got agree with you. No,
beta's one point zero. It's always one point zero. And
(07:51):
I so said, yeah, but what one point zero is
in twenty twenty five is different than what it was
in twenty twenty one. You know, they are abouto total upmarkets,
they're a montotal deal markets, and you're telling me it's
always one point zero. Again, let me go back to
my revelation running the City of New York. If I
have a down ten percent market and I'm only down eight,
(08:12):
I've done a great job and I've outperformed by two
hundred basis points. Right, but I soil only have ninety
two cents to upset my liabilities. Yeah. Right, If the
market's up ten and I'm only up eight, I've done
a horrible job of underperformed by t to hundred basis points,
but I've got a dollar eight to pay the pensions,
which is better what measures my skill, but the other
actually measures is the function I'm trying to do. And
(08:34):
so system level of investing tries to focus on the
function and how do you improve beta, shift the whole
market up into the left in investments speak, which means
less volatility, more return, and then apply MPT atop a
better opportunity set.
Speaker 1 (08:51):
Yeah, so I would, I mean, certainly, I would suspect
the reason why beta is so solid is because you know,
there's almost this FATA company to it where it's you know,
beta is what the it is. So you're saying that,
you know there are things that can be done to
do that, so you know, you know, when I was
in business school, it was always you know, it was
systematic risk was often referenced to as non diversifiable risk,
(09:14):
the implication meaning that you can reduce financial risks through diversification,
but at the end of the day, there's just some
risks you can't avoid. But you're saying that's not necessarily true.
Speaker 2 (09:23):
Well, I actulutely agree it's non diversifiable. That doesn't mean
it's not nonmitigable, right, And the problem is we've all
focused no offense to mister Blueberg got Bloomberg trading terminals, right,
that's where you invest. You move assets around to reduce
climate change, antimicrobi resistance risk risks across an entire industry,
(09:50):
like the repeated collapses of tailing dams in mining, you
actually have to go into the real world. And so
the difference is for MPT based investors, you tried to
diversify idiosyncratic risk, and the field you're playing in is
capital markets. For systems level investing, it's all that, but
you're also trying to reduce systemic risk. Let me justify that,
(10:11):
which is risk to the systems that results in the
systematic or non diversifiable risk in the capital markets. But
to do that you have to went to the real world.
And that's not something that investors had for the last well,
well that public equity investors have for the last fifty
seventy five years been comfortable with. Private market investors do
(10:33):
it all the time, right, right, But so in some
ways this is a return to the way investing used
to be before MPT said let's focus on idiosyncratic risk.
Speaker 1 (10:47):
So now you're speaking the language of ESG currents. That's
it's not about you know, let's do this because it's
the right thing to do.
Speaker 2 (10:53):
We love hugging.
Speaker 1 (10:54):
The trade is this is a way to enhance your
returns to help obligations. Not that doing the right thing
is something to be spoken down on to, but just
that this is all about financial returns and how do
we enhance returns, especially in the face of having an
obligation to pensioners and other clients.
Speaker 2 (11:14):
You know, I co teach at Columbia with my fellow
professor Bill Burkhart. My book movie Beyond Modern Portfolio Theory,
which I wrote with Jim Hawley, came out same time
Bill's book Twenty first Century Investing came out. He co
WROTD with Steve Leidenberg, and I always tell the students
in the first class, I'm really boring. All I want
(11:36):
is a better risk return profile for my portfolio. Right
Bill is great. Bill comes from the impact side of
the world, and he wants to save the world. And
the interesting thing is that we both converge on the
importance of systems. We also both realize you're doing ESG courage.
(11:57):
You know how term get messed up and thrown around
and demonized if system level of investing gets associated with Oh,
it's just another word for quote ESG or climate. It's woke, right,
And I don't know necessarily think there's anything wrong with
being woke, but the way it's been demonized, that will
(12:19):
be the death knell of it, right, because it is
about risk and return. It's about improving what beta represents
and then allowing MPT to do its magic above it.
Speaker 1 (12:31):
So what does this look like in practice? What are
some of the effective tools of system level investing? Are
there some examples you can share?
Speaker 2 (12:37):
Sure? The most common is systemic stewardship, And so you know,
traditional engagement or stewardship with a company is what Elliott
might do or Carl Khan or Bill Ackman. You have
an underperforming company and you try and turn around the company, right,
and let's call that alpha stewartge right, You're dealing with
(13:01):
the enterprise value of individual company. Systemic stewardship says, what's
the issue? So let me not take climate change because
everyone takes it, and just take I think that affects
a broad swath. If you're going to invest in mining,
and your Apple iPhone and everyone's everything nowadays has rare
(13:23):
earth materials and other things in it, so we have
to have minding if we're going to decarbonize. It's needed
for electrification. But it turns out that there were minding disasters,
you know, every few months, the most famous one being
one in Brazil where when you mine all the stuff
(13:43):
you don't want, you have to throw away somewhere right
the tailings, and in this case it was liquid. It's
a tailing dab holding a tailing pond and it collapsed
killed two hundred and fifty four people. At first, the
Swedish pension funds and the Church of England pension fund
commissioners started talking to Valet, which was the owner of
(14:05):
this damn about you know, you got to do better.
They soon realized that this actually was a systemic risk
because there was sort of a race to the bottom.
The cheapest way to build the tailing dam was also
the one that was going to collapse the most often,
and no one knew where they were. And so they
worked with the industry to set up standards for tailing dams,
(14:29):
called the Investor and Industry Tailing and Mining Initiative. And
they first thing they had to do is find out
how many of these dams there were, because they often
are in remote regions that you know, I live in
New York. I mean, let's be honest. We have a
you know, I didn't know where this place in Brazil was, right,
(14:49):
And so they mapped eighteen hundred of them. They got
the industry to agree, they brought in a couple of governments,
they brought in the UN, and now there standards for
tailing them. So that's what I mean by how you
go systemic stewardship. They weren't dealing with valet, they were
dealing with the problem, right.
Speaker 1 (15:09):
That makes a lot of sense. So have corporations on
their boards been receptive to this worldview?
Speaker 2 (15:17):
Some have, some haven't, often a lot of when there's
something that's sectoral, and it also depends on jurisdiction. Obviously
Europe is much more accommodating than some parts of the US,
although parts of the US are US. And let's deal
with the corporate side of the investor side, because I
(15:38):
mostly deal with the investor side. So the binding Itaian
initiative is an example where the corporation's joined forces. Similarly,
antibicrobial resistance is where you breed super antibatic resistant bacteria
are is scheduled to cost millions of lives and hundreds
(16:02):
of billions of dollars in the next ten years. Nordea
Bank went and found that one of the biggest contributes
that was the strip of pharmaceutical company manufacturing sites in
India where they manufacture generic antibiotics. There was a lot
of groundwater affluid and that in fact created the perfect
(16:25):
breeding grounds for superbugs. And they worked with those manufacturing
plants and with the Indian government and that's basically a
solve problem there right now, there's overuse in various other places,
and so often the place that I find or the
condition I find industry to be most accommodating is where
(16:48):
they know there's a race to the bottom to externalize costs.
And most CEOs or boards don't want to wake up
in the morning and think they're doing something nasty. They
just don't want to competiti to be able to externalize
the class to them not. So if you can set
a standard, which is another tool of system investing that
(17:09):
you can get buy in, you can actually have everyone
on a level playing field. That's when I find the
corporate side to do the most. The investing side is
really interesting. Asset owners, especially big woods have picked up
(17:29):
on this. I mean, and it's not new. Norgest Bank
in twenty twelve said there were universal owners and so
why would we do something we owe a slice of
the economy. Why would we do something in one part
of our portfolio that damaged another part. GPIF in Japan,
the largest pension play in the world, said the same
(17:50):
thing in twenty seventeen. And now you've got places like PGGM,
the Dutch pension giant, changing their entire philosophy for what
they call two D risk and return to three D
risk and return and impact. You've got cal STIRS in
the US doing systemic stewardship. University Pension Plan of Ontario
(18:12):
in their investment belief statements draws out why they believe
they need to reduce systemic risk in order to have
long term sustainable capital markets HESTA and Australia. So the
asset owner side, the really large universal owners, it has
a fair amount of pickup. Now, I don't want to
(18:33):
exaggerate this either, right, and I will just mention that
some asset managers BNP, POWERBA, Legal and General will also
have aspects of this. I don't want to exaggerate it.
Last time, I looked, there was three to five trillion
dollars sort of in what I would call a journey
towards system level investing. There's one hundred and fifty to
(18:54):
two hundred trillion yeah, out there right. So on the
one hand, you know, three to five live trullion is
a lot. On the other hand, it's a minute portion.
But our books came out in twenty twenty one, so
it's four years since the books came out. We've been
talking about it and writing papers for ten years. I
(19:15):
would tell you that modern portfolio theory didn't catch on
until the nineteen eighties. It was written in nineteen fifty two. Wow.
In fact, until nineteen ninety nine, the state of Indiana
prohibited its pension fund from investing inequities. So, you know,
things change slowly. And I am very pleased at the
progress and the attention in academia and in the consulting field,
(19:42):
the people consult to large asset owners and in asset
management and asset ownership that it's getting. So, you know,
I want to give you real numbers. I don't want
to say, oh, yeah, everyone's doing this. They're not, but
enough are and and many of them are real thought
leaders in the field, like PGGM, like People's Pitch, and
(20:06):
FUD of the UK, like UPP in Canada, like Calsters.
Speaker 1 (20:11):
So the biggest pushback I hear on this. And while
asset owners and some of the big portfolio managers, you know,
they're interested about their whole portfolio, their universal owners. They
want to minimize risk across their full portfolio. But you
know the pushback I hear is the management and the
board of each individual company. They still have a fiduciary
duty to maximize the risk return profile of their own company.
(20:33):
So how do you deal with that tension between you know,
maybe optimizing system wide outcomes versus maximizing risk return of
an individual security.
Speaker 2 (20:43):
Let me first give you a caveat that is true
in the United States. That is not necessarily true in
Europe or Japan or elsewhere, but you correctly state the
situation in the US. The question is a balancing act.
What can you do that? First off, they're windwinds, right,
(21:07):
but those are easy to discuss, So you know, wow,
that's great. You know, Coca cola needs clean water. Let's
make sure we have clean water. Okay, But there are
cases in which you can boost your enterprise value by
externalizing costs, no doubt about it. The question becomes one
(21:28):
over time what is material right? And materiality is not
a fixed set of things. I often ask my kids
if they know what a major source of loans in
the London interbank loan market was in the early nineteenth century,
and no one guesses what it was, which was the
lives of American slaves. Wow. Yeah, I mean it's sort
(21:50):
of shocking. But if you think it's eighteen twenty, right, yeah.
And so what happens when an individual company or enterprise
acts in a way that is out of alignment with
(22:11):
what society thinks it should do. The societal license to
operate concept? Sometimes nothing, let's be real. But sometimes first
there's reputational risk. I will tell you that if you
work for a tobacco company, they will admit that they
have to pay more to hire people. So sometimes there
are cost issues. Over time, there could be regulatory risk,
(22:34):
and over time, as in slavery, it can become illegal.
Now that's obviously a dramatic example, I mean, but it
does illustrate what happens, and you you can see it
now even with coal, I mean, coal has rereaded it's
(23:00):
you know, the cheapest electrical on a life cycle basis
is solar. And so you see entire countries, including many
Middle East countries where they have tons of oil, right,
they're building solar right right, because the economics of it.
When something is out of step with society, people throw
(23:21):
money at it to find a solution. That's one of
the other tools of intentionality as we call it, which
is you find the systemic opportunity and you try to
do it. So again, things are never all or nothing.
There will be sub companies that can successfully externalize cost
for a long time and no one will notice or care.
(23:42):
Maybe they're not important. There are sub companies that will
be caught tomorrow, and there are other companies that are
somewhere in the middle. And it will also depend on
the jurisdiction you're in and with the societal expectations of
the jurisdiction are.
Speaker 1 (23:56):
And certainly there's a component of time horizon as well.
I mean, you know, the Middle East country may maybe
in their best interest to milk the oil fields today,
but then reinvest those profits into.
Speaker 2 (24:08):
Well, except they're building you know, they're all their sovereign
wealth funds to try to diversify themselves away from oil
because they understand it. Also, I want to talk about
time horizon for a second. I find time horizon fascinating.
I've looked at functional MRIs of temporal decision making and
everything else, but I want deal specifically one thing. I
(24:29):
do think that the sustainable investment can be sometimes get sloppy.
It says, well, it's a long term risk. And what
people not in the community here when they hear that
is you can't prove it. Therefore you say it's long
term and you know no one can disprove it, and
blah blah blah blah. So when it comes to climate change,
for instance, it's not long term anymore. You know, we
(24:49):
get wild would a simple example, wildfires are Los Angeles, Okay,
affects the municipal bond market, affects the real estate market,
affects some economic output, and people go, well, that's okay,
I'm not on the West Ages. Really still think called
the reinsurance market. All reinsurance rates went up. That was
a cost to the world, cause or accelerated by climate change.
(25:16):
So you start to see the impacts of systemic risks,
now not long term.
Speaker 1 (25:24):
That makes a lot of sense. Especially you know with
some of the things like oil fields and oil pipelines,
there are such a long term planning that you have
to do that you really have to think about the
lifetime of the project, not just what's my.
Speaker 2 (25:38):
So of the better systems thinkers in the world or
Cabridge University. I have to thank Bloomberg for this. They
have developed a new Boded Dicks. Do you know about this, Ah, well,
you're about to hear about it. It's it's it's the
beecam Investment Grade Boded Dicks and is being rolled out
(26:00):
I Bloomberg Q three. And what they have done is
you could be a fossil fuel company and you're still
in the index. But the purpose of the BOD cannot
be to expand the fossil fuel footprint, as you say,
over time. So you can't build a new liquefied gas terminal,
(26:21):
you can't develop a new field or build a pipeline.
And the idea is to direct capital away from those
things which will memorialize or institute twenty or thirty years
more of fossil fuel. So it's actually a very intelligent
use by people who are the University of Cambridge self
(26:45):
identifies as a system level investor. Doctor Ellen quickly helped
develop a lot of the philosophic framework for this. And
they're also very smart because while we talk about stewardship
often in the public equity market, that's a secondary trading market.
The capital doesn't really go to the companies. There's a
(27:06):
very minor effect, whereas fixed income bonds are primary issuance.
And so to the extent that this orient's capital away
not from someone who's fossil fuel company, They've been doing
it for years. They try to figure out how to transform,
(27:27):
but to people who to companies which are saying, no,
we want to lock in the use of fossil fuels
for next twenty or thirty years. It's a very intelligent,
in my mind, constructed index. So coming Q three to
your bluebird TRIBERL.
Speaker 1 (27:40):
Yeah, for the record, we this is not a paid
endorse It.
Speaker 2 (27:42):
Was not a paid endorsement, but I mentioned it because
I think it's actually one of the more clever and
potentially impactful things that a system level investor has done,
which is try to set a standard through an index creation.
Speaker 1 (28:00):
I mean, so I have an oil and gas background,
you know, covering that industry, and it always you know,
it seems to be it's not a black and white
issue of you know, there are some projects you can
certainly invest in that, you know, maybe not ideal today,
but for the world's given constraints, may make sense. But
there's other investments that, as you say, lock us in
for twenty to thirty years.
Speaker 2 (28:18):
Look, we clearly don't have the ability to electrify without
oil and guests. And we're recording this on a Wednesday
on Thursday, right, not going to happen, and the idea
that it will is wishful thinking, I think some people,
(28:39):
And so I think this is a very intelligent way
to say, let's try to drive capital to solutions without
impeding the day to day life of the world.
Speaker 1 (28:53):
So, speaking of the day to day life of the world,
the current administration has already taken a number of measures
to limit the rights of shareholders to weigh in on
corporate decisions. On top of that, you have a corporate
governance race to the bottom, with several states watering down
regulations to attract companies to reincorporate. I assume you have
an opinion on US.
Speaker 2 (29:12):
It's interesting. I think Bob Monks, one of the pioneers
of corporate governance, has recently died and was a Reagan
administration Department of Labor official. Said capitalism without owners will fail.
What does that mean? What does that mean? It means
that in a capitalist society, those who provide the capital
(29:35):
have the right, but also the obligation, to suggest what
the highest and best use of that capital is. We
are I think if there is a corporate governance philosophy
of the current administration is what I would call corpocrisy,
(29:56):
right you want, they try to empower corporate managers, not
necessarily the owners. So you see Texas doing things to
attract Elon Musk. You see the sec making it harder
(30:20):
for owners to put forth proxy resolutions. I think it's shortsighted.
I will tell you a story that indicates how short
sight it is. As you know, in Texas they also
have this blacklist I don't know what to call it of.
(30:44):
You know, don't invest with companies who have been thought
to quote boycott end quote fossil fuel companies for a
long time. Black rockers on that list. At one point,
a land trust in Texas wrote the Attorney General and said,
we have this private equity portfolio and it has blackrock.
(31:07):
What should we do? And he said, well, technically private
equity isn't covered by the law, but it's blackrock, so
if you can trade it in the secondary market, get
out of it. You know what that private equity fund was.
There's oil and gas pipelines, right, and so we have
reached I mean, I'm just going to call it for
what I think it is. That is a socialist phenomenon,
(31:28):
not a capitalist one, where government favors or disfavors certain
industries and then ultimately decides to favor or disfavor individual
companies like Blackrock or you know, or someplace else. And
you know, we tried that, or we didn't try it.
The Soviet Union tried it. It didn't work so well.
(31:52):
And so if you're going to have capitalism, you have
to empower owners to feel that they have some oversight
over their capital. There are very few people who I
would trust when they come to me and say give
me some money. I'm not going to tell you what
(32:12):
you're going to do. I'm not going to report on it.
I'm not going to write. And yes that's overstating where
Texas is going. But the rights are being limited and
at some point it just doesn't become an attractive place
to put capital, not immediately. You know, the most efficient
(32:33):
form of government is a dictatorship, but it's not necessarily
one that has proved sustainable over time. And so if
you're going to create a form of economic organization where
you empower corporate managers over the providers of capital, that's
(32:54):
no longer capitalism.
Speaker 1 (32:55):
That's very true. And in terms of the asset owners
that are I mean, you mentioned quite a few looking
at system level investing, but is there kind of a
chilling effect going on?
Speaker 2 (33:05):
I mean, obviously, oh, there's a huge chilling effect. I mean, look,
one of the other things that people are talking about
in Washington is regulating proxy advisors. For those of you
who don't know, proxy advisors suggest to asset owners or
asset managures how they should vote on various issues, including
who should be on a board or or if there's
a request for a report on something that the company
(33:27):
from how they impact climate change or greenhouse gas emissions
or whatever. And a number of the Business Roundtable the
Chamber of Commerce have made it very clear they do
not like the current situation where there are two dominant
proxy advisors because some four percent of recommendations are against management.
(33:49):
And you know, say on pay has been a flashpoint
because they're often against management on executive compensation. I wouldn't
like having people voting about compensation either, but if I'm
taking their money, you know, that's sort of the trade.
In reality. I don't believe they have the votes in
(34:13):
the current Congress with the slim majority of the House,
to pass proxy advisory regulation, and the SEC just lost.
I tried to regulate proxy advisors in the DC courts,
so they can't just do it unilaterally. They need legislation.
That doesn't mean that they can't hold hearings, that they
(34:36):
can't make document demands, that attorney generals who are of
a particular political bid can't write to asset owners or
asset managers in other states, and that does have a
chilling effect. And I think the people who would like
(34:56):
to regulate proxy advisors understand that and regard it a
is a win. I am aware, for instance, of one
on ESG, generally one trillion dollar US based asset manager
who got a letter from seventeen red state attorney generals,
a cost of a million dollars in legal fees and
(35:17):
document production and everything, and they had two years before
hired a very prominent stewardship team and they have let
them all go. You know, I don't think it is
affecting the asset owners who are fort the sort an
economic basis. I do think it is affecting asset managers
who thought this was a way to gather assets. And
(35:39):
quite honestly, every you know, they were allies as well.
And so you know, there are people who say, oh,
that's great, we now have only people who truly believe,
and I'm seeing them going, excuse me, and economics, I'd
like another trillion dollars on my side, please. You know,
so it does have a chilling effect. I'd be foolish
(36:01):
to say it doesn't.
Speaker 1 (36:03):
All right, last word here, So imagine lis scenario you're
called to Congress. They're thinking about, as they are currently doing,
regulating the pension fund law ARISA around what canon can't
be considered. They're saying, you know, we don't want this
woke stuff. We don't we should only focus on profits.
What do you say to that?
Speaker 2 (36:23):
Every What I would say is every law that has
been passed through a red state about this has a
fiduciary out and by the way, it's not just on
the left on the right, it's on the left as well.
Our gun just passed the law mandating the vestiture. I
think that's equally silly because if you are going to
say you start with an economic analysis that fits into
(36:47):
your fiduciary obligation, then you should let people do that.
There there is a lack of tolerance and people are saying,
I know what fits right, and it's pure politics on
their point, whether from the left to the right. So
as I said, our God did that. On the right,
(37:08):
you know, the US federal thrift savings word isn't allowed
to invest in China. Now you want to tell me
you know that's an ESG political decision, if you will.
There was no economic analysis and what it does to
the ability to track it, index or do anything else.
And the problem on both the left and the right
(37:28):
is they make the same mistake. They start. The right
says you shouldn't be dealing with issues like climate change,
and the left says you're not doing enough to deal
with issues like climate change. And they're both making the
same mistake, which is they are looking at that issue
instead of the economic impact on the portfolio. That universal
(37:50):
orders look at and try to adopt and therefore go
to system level investing to improve. As you said, it
all comes around to risk and return.
Speaker 1 (37:59):
Great, John, thanks so much for your time and for
our listeners. You can find more information on sustainability issues
on bispace ESG go on the Bloomberg terminal. If you
have an ESG quandary you would like to ask bi's
expert analysts or learn more about our research, send us
an email at ESG Currents at bloomberg dot net. And
if you like this episode, please subscribe on Apple, Spotify,
(38:21):
or your favorite podcast platform
Host
Eric Kane
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