Page 1 Page 2 Page 3 Page 4 Page 5 Page 6 Page 7 Page 8 Page 9 Page 10 Page 11 Page 12 Page 13 Page 14 Page 15 Page 16WHAT IF THE CAPITAL MARKET COULD SOLVE THE SOCIAL AND ENVIRONMENTAL PROBLEMS IT HAS HELPED CREATE? Conventional wisdom has been that it should not. In 1970, Milton Friedman warned against business becoming entangled with the public good.2 The title of his provocative New York Times Magazine article summed up his views on the matter—“The Social Responsibility of Business is to Increase its Profits.”3 Business has no business taking on societal needs. That’s what government is for. That’s why we pay taxes, Friedman argued. He described the mixing of societal (social and environmental) and corporate financial goals as a “funda- mentally subversive doctrine.”4 But what if businesses could make more profit by integrat- ing societal goals into their business models? Then it would be financially irresponsible for businesses not to integrate societal goals.A new way to look at $143 trillion would emerge—as the solution rather than the problem. The answer to this question—can a company generate more profit by integrating social responsibility—has been sought for 40 years. It’s one of the most contentious and debated ques- tions in economics today.5 6 Yet the number of investment firms that offer socially responsible investing (SRI), investment strategies that seek to consider both financial return and social good, has exploded in the last several years. In the U.S. alone, the pool of assets in socially-responsible portfolios grew from $2.2 trillion to $6.5 trillion between 2005 and 2014 (300%).7 Something is fueling this growth. Financial returns? Ethical“returns?” Both? It’s clear there is a growing market of individual investors who do want their investments to do “good,” or at least not to do harm in the process of making money. Sustainably responsible investing can be lucrative. In 2004, Al Gore and David Blood (formerly with Goldman Sachs) created Generation Investment Management, with a belief that shareholders will make more money by investing in companies that manage for social and environmental performance, not just financial. During the period of 2004 to 2014, the second-worst economic era in our country’s history, Generation Investment Management averaged over 12% annual returns, 5% better than the conventional MSCI equity index of 7% during the same period. However, this is just one institutional investor. If the capital market is going to save the world, SRI will need to start attract- ing investors who are not driven by ethics. OPPORTUNITY OR RISK? While the growing SRI industry might be responding to a new-found ethic among some investors, all investors are sensi- tive to financial risk. The notion that companies have financial risk either from the direct impacts of climate change (e.g., droughts, storms, flooding) or from new policy (e.g., a tax on carbon) is starting to be appreciated in the investment sector. In December 2015, 190 nations gathered in Paris and com- mitted themselves to limit global warming to no more than 2ºC. If all the nations on earth meant what they said in Paris, the world will have to leave most of the known reserves of fossil fuel in the ground, unused. These assets will become economi- cally“stranded” underground, and worthless. Nearly a year before the Paris conference, Arjuna Capital,8 one of ExxonMobil’s shareholders publicly called on the oil company to assess and disclose its financial risk to a future “decarbonized” economy (one that relies less on fossil fuels and more on renewables). ExxonMobil’s stock value is tightly linked to its known oil reserves—including those still in the ground. Arjuna logically wanted to understand the risk to its portion of the assets if, for whatever reason, the world demand- ed far less oil than ExxonMobil predicted. What was ExxonMobil’s response to Arjuna’s request?9 Their conclusion was that the human demand for cheap energy would trump any desire to limit global warming, and they saw no material risk to their assets This may or may not be true. Fossil fuels are not cheap when you add in their externalities like increased storm inten- sity and the cost of coastal clean-up. Right now, that cost is born by individuals and government (recall Friedman’s view “that’s what government is for”). What if society required that fossil fuel externalities be accounted for in the price of oil? Paris laid the groundwork for exactly that scenario. A company should want to assess this risk and, depending on the results, take steps to reduce it. So what is the climate “exposure” (or risk) of the full $143 trillion? It’s been estimated to be about $7 trillion, or about 5% of the total asset pool.10 Five percent is a lot to lose to the climate. Let’s look at how one investment asset class might deal with climate risk. Agriculture is one of the fastest-growing investment asset classes. 8 | Manomet Partnerships for Sustainability • Spring / Summer 2016