Published on 18 February 2021

Steps to Investing talks to fund giant M&G’s Head of Sustainable & Impact Investing Ben Constable Maxwell about the birth of a new breed of capitalism and investors’ role in its adoption.

Capitalism hits a bump in the road

Prior to capitalism, life wasn’t great for most people. As Rutger Bregman, a Dutch historian, notes in his book ‘Utopia For Realists’: “for roughly 99% of the world’s history, 99% of humanity was poor, hungry, dirty, afraid, stupid, sick, and ugly”.

Then in the 17th century, capitalism began to change things. According to Our World in Data – a Bill Gates founded non-profit – in 1820, roughly 89% of the world lived in extreme poverty. By 1929, it was 66%. And by 2015? A smidge under 10%.

Percentage of population in extreme poverty

What history shows us it that capitalism is a mighty system for allocating resources, because it raises productivity, societies and living standards enormously through ingenuity and innovation.

Unfortunately today, frustrations with the system are rife. Investment and wages have slumped. Its activity has wreaked havoc on the environment. A sea of debt and a cavernous wealth gap has emerged. And all in lockstep with a polarised political discourse that’s rankling society.

History tells us of similar flashpoints, with dire consequences. For example, rampant inequality during the 1930s Great Depression eventually led to the rather nasty autocracies and global wars of the 1940s. 

Cowed under its failures, capitalism is having a re-think. The theme at last year’s World Economic Forum in Davos was ‘stakeholder capitalism’. Could this new approach be the saviour of capitalism?

It begins with Freidman

In the 1970s an economist from Chicago, Milton Friedman, wrote a paper entitled: “The social responsibility of business is to increase its profits”. Boardrooms across the globe latched onto the doctrine, and began to put profits and shareholders at the centre of business. Governance, incentives, stock options, compensation committees and independent boards all aligned in the pursuit of this endeavour. So, if the 70s picked up this ball, then the 80s took it and ran with it. 

Ben Constable-Maxwell is head of sustainable and impact investing at M&G, a large UK-based asset manager, thinks Friedman was actually misunderstood:

“There’s a view that Friedman espoused an amoral position. That the social purpose of the business was just to deliver value to shareholders, at the expense of everyone else. This was an over-simplification of what he was saying.”

“He thought the focus on shareholder value would take into account other stakeholders – because you need them as part of a business’ activity.”

“Unfortunately, the headline of the essay was really the only thing that got picked-up by business management. It just became a nice headline to hang corporate strategy off.” 

“It had an enormous impact.”

As a result, the pursuit of profits led to questionable boardroom ethics and an aggressive approach to building market share. It super-charged corporate power, which became concentrated and unchecked. As executives focused on creating money for their shareholders (and let’s face it – themselves), a disconnect grew between business, the real economy and society. Regulators were toothless to stop the bad behaviour. And when they did and fined offenders, it was just absorbed as a cost of doing business. 

Then, the Global Financial Crisis hit. It would challenge the Friedman approach. 

The green shoots of change emerge across capitalism

Ben continues: “The Global Financial Crisis proved to be a seminal moment. It was a clear indication that elements of capitalism were completely out of control. Incentives had been skewed towards short-term casino capitalist mentality.”

“The financial crisis was a massive shock for the real economy, real people and communities. Lots of people lost their jobs and homes. It led to austerity, which hit people on the bottom-rung the hardest. It cut lots of social welfare and public services needed to help them through an increasingly difficult period.”

Boardrooms needed to restore the trust they had broken and pressure for change was building broadly across society. For investors, the investment risks associated with bad behaviour were clear.

As a result, a generational shift in strategic corporate thinking emerged. Boards started to focus on the whole stakeholder chain, including customers, employees, suppliers, and local communities. ‘Shared value creation’ would be the new mantra, combining softer environmental, social, and governance (ESG) goals with more traditional financial metrics. 

Consequently, investors needed a fresh lens to assess these new ESG metrics, and began adopting the ESG framework promoted by the UN-backed Principles of Responsible Investment (PRI), launched in 2006. 

A framework for measuring stakeholder businesses

The ESG framework helps investors understand the investment implications of environmental (E) factors such as carbon pollution or water usage, social (S) factors such as the treatment of employees or ethics involved in the supply chain, and governance (G) factors such as transparency with shareholders or the independence of the board. 

Ben explains: “ESG is a framework for thinking about all the risks and opportunities a business has. But away from the balance sheet – it’s not the financials. By this we mean risks around reputation, or societal contribution, or regulatory fines. Asking whether the company is properly governed, or increasing diversity to improve decision-making. It could be whether it’s reducing its emissions to be more efficient. All of these considerations are contributors to business success”.

Being a truly sustainable company, Ben believes, goes far deeper than ESG scores and ticking the right boxes to satisfy investors: “The idea of corporate purpose is really central and powerful. A company must set-out why it exists, what it’s here to do.”

But Ben concedes that purpose can difficult to measure: “Having a high-level purpose can dissolve very quickly into greenwashing, creating a false impression of sustainability. Purpose is about walking the talk. You need to know how management, strategy, communications, workforce all aligned with the purpose.”

“Purpose is much stronger if it encapsulates all of its stakeholders. ‘We want to inspire our employees to work for this company because they’re helping to solve a global problem. Local communities are important because we need to build a relationship with them to be successful in the long run. We support a governance agenda in a sustainability area because that helps us with regulation.”

Investments in ESG gain traction

With the winds of change behind it, the approach spawned a worldwide ‘sustainable investment’ industry with assets under management of around $30.7trn, according to 2018 figures. 90 of the world’s top 100 asset managers are now signatories of the PRI. BlackRock is its biggest scalp, with asset under management of $8.68trn. 

Likewise, private investors are seeking more ESG options. According a study from last year by the Morgan Stanley Institute for Sustainable Investing, interest in sustainability among private investors keeps on growing, with 85% switched on to ESG issues, up 10% from two-years previously. 

What is more, it has become the darling of millennial investors, who are particularly engaged in issues such as climate risk, social injustice, poverty, and access to healthcare. The same study found that 95% of millennials were interested sustainable investing, up 9% from 2017. 

In addition, a razor-focused subset has spawned out of it: impact investing. Rather than consider how ESG factors affect the business, impact companies are there to directly solve sustainability issues.

Ben describes the difference: “Think of ESG businesses as outwards-in, and considerate of how external factors such as climate change, pollution or labour relations affect the firm. ‘Impact’ businesses are inwards-out – and singularly focused on a sustainability issue.”

Focus on stakeholders here to stay

There are some encouraging signs that the stakeholder approach will take hold as the dominant model of capitalism. 

The most encouraging came in 2019, when the Business Roundtable – an influential lobby group of top US CEOs – changed a decades old declaration. The statement included a commitment to “all stakeholders: customers, employees, suppliers, communities and – (last in the list) – shareholders.”

In conclusion, Ben agrees it’s here to stay: “There’s no turning back in terms of responsible business practise. Using transparency as a stick to encourage better behaviour – regulation is going to protect against that. Consumer preferences are going to demand it. And investors are almost universally engaged on fulfilling their responsibilities by pushing for better standards on ESG.”