Yellow brick road to the impact economy

I'm from San Francisco, not Kansas, but when I stepped off the elevator at the Lexington Avenue headquarters of Bloomberg LP, it felt like Oz.

Around the soaring 6th floor atrium, no walls or receptionists guard the newsrooms. Senior executives hold meetings on a Big Pink Couch. Billionaires like Eric Schmidt, chairman of Google, visiting the same day, grab their own drinks before strolling to transparent conference rooms for their billionaire meetings.

From this Emerald City, Bloomberg’s river of business data and news is a yellow brick road of price information, market signals, trend detection and transactional data to trading desks around the world.

I was at Bloomberg to explore corporate sustainability data as a fuel for impact investing in transformative innovation. The kind required by, say, four billion new middle-class consumers being unleashed on an increasingly stressed planet. My hypothesis: Impact data will merge into sustainability reporting, creating a pipeline from corporations and institutional investors to impact entrepreneurs and small and growing businesses.

So I sat up when Daniel Doctoroff, Bloomberg’s CEO and former deputy mayor of New York, said the markets movement toward sustainability had reached a tipping point. More specifically, Doctoroff declared his solidarity with the ESG faithful at ESG-USA, convened for the fourth year by the British publication Responsible Investor. “We’re a believer,” he said.

If ESG is not yet part of your buzzword vocabulary, it will be. Environmental, Social and Governance are the topline categories for sustainability reporting by corporations, agencies and investors. Keep it straight: ESG differs from SRI, or socially responsible investing, going beyond the exclusion of bad actors to the identification of best-in-class performers. CSR, for corporate social responsibility, has effectively morphed into ESG as the real drivers of risk and return have been identified.

Doctoroff said the still-inadequate integration of sustainability data into market information services hides a classic “externality,” the estimated $33 trillion value of air, water, climate and other global ecosystem services.  “That represents a huge market failure with potentially profound implications,” he said.

Doctoroff cited this fall’s trifecta of Hurricane Sandy, President Obama’s re-election and the opening of the California carbon market as tipping the markets toward sustainability. The California coup was something of a sleeper, but Doctoroff was keen on last month's first auction of carbon credits in the world’s 8th largest economy. With 35 percent of the world’s population now in carbon-market regions, there is finally a market price for carbon, and even renewed talk of a carbon tax. That’s in the sweet spots of both Bloomberg, the company, and Bloomberg, the mayor, who called for such a tax in 2007.

Invoking the 'M' word

Doctoroff even invoked the ‘M’ word. “We think these issues are material to us and to our customers.” In the markets, materiality means: you gotta report it, because it directly affects shareholder value. And that means traders, analysts and others will be watching for signals in resource depletion, supply chain working conditions and leadership diversity, among many other indicators. Until now, most ESG reporting has been voluntary, under a welter of compacts, initiatives and commitments, such as the United Nations’ Principles for Responsible Investing.  But the number of companies that file ESG reports has grown from 700 four years ago to 5,000 now, out of 20,000 public companies that Bloomberg tracks. That's close to a tipping point.

“Big business will at some point realize there is much more to be got from adopting this new behavior, rather than resisting it,” Philippe Desfosses, the CEO of ERAFP, a large French pension fund that has long been “socially responsible,” told the conference. “It’s a way to discriminate between the companies we want to invest in.“

The theory is that financial data is increasingly ubiquitous and generic, so the best place to gain an information edge is in non-financial data: carbon emissions, waste reduction, community relations, corporate governance and hundreds of other indicators. From there it’s a short step for the data geeks to generate algorithms that use superior ESG performance to signal long-term market outperformance -- ‘alpha’ returns on the upside and risk-reduction on the downside. And of course the best time for such analysis is when information is not yet fully priced into the market, as sustainability data is not now.

“The research is there in regards to the alpha case,” said Michael Jantzi, the Toronto-based CEO of Sustainalytics, headquartered in Amsterdam. He pointed to Deutsche Bank’s conclusion in June (view pdf) that firms with high ESG ratings have a lower cost of capital because they are lower risk in the long term. Another convert: Towers Watson, the big pension consultancy, which through its Telos Project (view pdf) promotes portfolio management that purports to account for transformational changes like slowing growth in developing economies; aging and workforce declines in developed countries; and resource scarcity and ecosystem pressure.

Big business will at some point realize there is much more to be got from adopting this new behavior, rather than resisting it,”

Philippe Desfosses

Impact investing, with its own set of acronyms and rating regimes, has grown up largely separate from corporate ESG reporting. Startup, mostly private, ventures are too small for large institutional investors, and information about their performance is not actionable by traders. Base-of-the-pyramid consumers, who require new business models and low price points, have not been at the center of most corporate strategy. Methods of accounting for positive social impact are even less mature than ways to track reduction of negative externalities.

But the data flow is gradually wearing down such obstacles. Private equity firms such as KKR & Co., Carlyle Group and Oak Hill Partners are all working with the Environmental Defense Fund to track, report and disclose sustainability results at portfolio companies. With private equity under political scrutiny, it’s helpful that such practices reduce greenhouse gases, waste and water use -- and cut costs without layoffs. EDF last week publicly released its assessment tool to enable other private equity firms to assess their ESG practices.

Nobody disputes the growth opportunities in emerging markets. EIRIS, which tracks more than 3,000 companies, collects data on 300 in emerging markets on more than 100 indicators, including bribery, human rights and climate change impacts. The Emerging Markets Disclosure Project (view pdf) of US-SIF Foundation, shows disclosure accelerating in places like Turkey, Malaysia and China, along with Brazil and South Africa. The new sustainability-index fund of the Mexican Stock Exchange is spurring transparency there.

Global standards

The raters are converging on global standards, with new initiatives like the Global Initiative for Sustainability Ratings and the Sustainable Accounting Standards Board. For a quick view of the landscape, check out the new Rate the Raters report from SustainAbility.

Over time, the ledger should expand from ameliorating the negative to rewarding positive impact, such as “disruptive innovations” that directly address human needs in a sustainably long-term way. Spotting social venture opportunities in global mobile connectivity and the ever-falling costs of smart phones, solar panels and health diagnostics and treatments has been the province of impact angel investors and mission-driven impact funds. But corporations can't ignore the coming transformations of food, water, health, education, energy, housing, sanitation and other industries.

Unilever, for example, explicitly seeks billions of customers at the base of the pyramid for a new set of appropriate-price products, including through local micro-entrepreneurs the firm sets up in business. Both Unilever and PepsiCo have installed executives at and invested in Physic Ventures, led by Will Rosenzweig, which finds consumer companies focused on health and sustainability. The dollars flow down but more important may be the data and innovation that flow up to corporate investors.

Private equity, risk mitigation, disruptive innovation, alpha opportunities -- it’s not hard to see the convergence of the worlds of ESG and impact investing data. (Data is the nexus as well between impact investing and the public-sector "aid transparency" movement -- see "Publish What You Fund." All of the efforts are trying to standardize on social impact measurement, disclosure and best practices. As impact investments increasingly signal broader market shifts they will become recognized as…material.

One good sign is the competition in the sustainability data business between Bloomberg, which began collecting ESG data in 2008, and arch-rival Thomson Reuters Corp., which the next year bought the Swiss data provider Asset4. Neither has yet embraced impact investing, for all the reasons noted above.

But Doctoroff declared Bloomberg is doubling down on sustainability data in order to provide information the market doesn't yet know it needs. “We’re putting money in even where it doesn’t make business sense," he said, "because we believe.”

So impact investing's yellow brick road may well wind through ESG reporting. Just repeat three times: “There’s no place like sustainable alpha.” All we’ve had to do all along is click our heels and follow the data.