Being responsible is more important than returns
In Sweden, responsible investments are words of honour. A new entrant lacking a robust policy for responsibility will find access to institutional investors difficult. This makes the insight that many large institutions lack the same careful approach to responsibility in alternative investments rather staggering.
Cat bonds, the asset class we manage, are by default investments that benefit society by providing insurance capital for large events, such as hurricanes and earthquakes, and thus enable insurance in locations where it is difficult or impossible to obtain commercial insurance coverage. An increasing share provides disaster relief in developing economies.
However, also fine fruit-baskets may contain rotten apples. There are cat bonds with doubtful responsibility merits. Though the vast majority offer economic protection against large catastrophes, the same construction can be used by gambling companies for insurance against jackpot payments. Historically, at least one bond has been used for insurance against economic responsibility for oil spills.
To make the most of the cat bond responsibility aspects, bonds that, directly or indirectly, support causes that are difficult to reconcile with a responsible approach should be avoided.
Many institutions have well-formulated policies of responsibility as well as processes for responsible investments. We have thus been astounded at investor meetings that many institutions don’t apply these policies and processes to alternative investments, such as unlisted equity, real estate, hedge funds and cat bonds. When hunting for diversifying and uncorrelated returns, responsibility is trumped.
Often these investors claim that responsibility analysis of alternative investments is difficult. This is partly true – a cat bond can be analysed using a traditional approach, such as ESG (economic, social, governance) indicators – but this is not really interesting, as the bonds are designed to minimise these and other types of counter-party risks. We thus primarily analyse the underlying insurance purpose when investing. This is a responsibility policy not driven by the expectation of higher returns for single positions, as the design entails that this will not happen, but by the conviction that our shareholders don’t wish to support any insurance purpose conceivable.
In terms of returns, our responsibility policy is about preventing shareholder flight, requiring us to liquidate positions under time pressure at less favourable conditions. This situation could occur if a bond triggered and enriched a jackpot winner in Holland at the cost of an institutional investor.
This is also my response to a common objection we meet, that the turnover rate of certain funds is so high that it prevents responsibility analysis. Of course, this is possible, though you have to make an effort to find relevant metrics for the specific fund and its shareholders. A minimal effort should, for example, be to maintain black lists for excluded investments.
Implementing responsible investments for alternative assets does call for a certain amount of ingenuity, but it is utter nonsense to claim that it can’t be done.
What is clear, though, is that little will happen unless investors put pressure on managers. In the long term, it is not sustainable to simply hope and wish that alternative investments don’t contain serious responsibility issues. Sooner or later, these issues will emerge and damage the investor’s reputation. Likewise, serious managers of alternative investments ought to welcome this pressure. It is not reasonable that an entire sector of the financial industry can refrain from being part of the trend towards responsible investments.