A Paradigm Shift in Investing - Are you Ready?
“Change is the law of life and those who look only to
the past or present are certain to miss the future.” —John F. Kennedy
From our first days in investment management, we are rightly cautioned against proclaiming, ‘this time, it’s different.’ While market history doesn’t repeat, it does rhyme – the current and admittedly substantial challenges we face may be new in magnitude but not in kind. Inflation, supply chain woes, asset bubbles, prolonged bull markets, swings between globalism and nationalism, political risk… all of these represent the rough seas that we must navigate as investors.
So, it is a truly exceptional moment when we acknowledge that there are several remarkable changes underfoot that will affect individuals, society, our economy, and the planet. As investors, it is our job to differentiate between the transient ‘rough seas’ that are the hallmark of equity investing, and the truly novel changes that will become permanent fixtures in our lives.
A PARADIGM SHIFT
At Radiant, we have identified three such changes, three things that really are different this time! Collectively, they represent a Paradigm Shift that will have lasting influences on capital markets and the asset management industry’s ability to generate alpha.
- Environmental, social and governance (ESG) influences, and investing with a stakeholder mindset
- Diversity, Equity and Inclusion (DEI) as an alpha generator
- Advancements in Data and Technology
Why now? To be sure, the COVID pandemic was a ‘tipping point’ as it has exposed the fragility of a global marketplace and how interconnected the world has become. The impact of the pandemic is being felt everywhere and is driving change on an unprecedented scale—proving that the speed of evolution knows few limits when necessity demands it.
As a result, these three changes will permanently embed themselves into the fabric of our industry and those who are unprepared or unwilling to welcome these changes and embrace new ways of thinking will be at a marked disadvantage.
Why are we certain? There is another quiet, slow-moving force to be reckoned with—one which is ushering in this Paradigm Shift and will ensure its permanence. This amplifier effect comes in the form of unprecedented demographic shifts which are driving new focuses and new behaviors, and a significant generational transfer of wealth that will serve to materially alter the profile of key decision makers. These investors look and behave differently than their predecessors.
It has been well established that Millennials, and even much of Generation X, differ widely from Baby Boomers and preceding generations, in their reliance on data and technology, progressive views on DEI and ESG, and support for a stakeholder capitalism mentality. Their voices will gain growing influence as we witness the largest redistribution of wealth in human history, with an estimated $68 trillion projected to change hands in the US over the next two decades. The so-called “tsunami of wealth assets” has been characterized as one of the most defining phenomena in financial services over the coming years. So, while the current generation of investors has indeed opened the door to these profound changes, it is the shift in power to the next generation that will cement the new Paradigm.
This Paradigm Shift will permanently influence the asset management industry and the generation of alpha in three critical and important ways.
ESG AND THE RISE OF STAKEHOLDER CAPITALISM
Rewind the clock ten years and you would have found very few mainstream investors talking about environmental, social, and governance (ESG) influences in the way that we do today. Once dominated by exclusions-based strategies, most sophisticated investors employ ESG criteria in a more robust way with the use of company operational information to both reduce risk and seek additional upside performance. The idea that ESG information is economic and material should hardly be controversial. As with most new developments, there will always be naysayers and those who challenge new thinking, but regardless of how one chooses to refer to it, the incorporation of this type of additional information represents a critical philosophical change among investment practitioners. Put simply, investment managers should want more– not less– information about how a company is competitively positioned relative to its peers.
As a key cornerstone of the Paradigm Shift, an orientation toward stakeholder capitalism is emerging in full force. This represents the recognition that companies are responsible to more than just their shareholders. They must expand their focus to include stakeholders like employees, suppliers, and customers, and even the environment and society at large.
A company does not operate in isolation – the economic engine that feeds the company must be treated in an honest and ethical manner; it should be protected if we are to collectively build value over the long term. While the idea of shareholder primacy has historically reigned supreme, asset owners have started to recognize that, to the extent a company is not aligned with broader stakeholder interests, it may face headwinds economically. The definition of ‘fiduciary duty’ is therefore very much in flux.
How we evolve into an economic system that embraces all company stakeholders and respects the finite and vulnerable ecosystem in which we operate will become increasingly critical. The business – and investment – winners of the future will be those firms who can bend the arc of a company from where it is to where it needs to be.
A key implication of the stakeholder capitalism ethos is that ESG investing must evolve. True stakeholder capitalism requires that asset managers connect their investment practices not only to company-level characteristics but to changes in the real economy. This is a daunting prospect for investors because it requires the adoption of an ‘impact mindset’. But if we are to truly understand the effects of our investments on stakeholders, it is paramount that we move past ‘ESG Ratings’ to instead focus more directly on how a company interacts with its ecosystem and what the resulting implications might be.
DIVERSITY, EQUITY, and INCLUSION
While Diversity, Equity, and Inclusion (DEI) are indeed a part of the larger world of stakeholder capitalism, we call it out specifically because of its importance to society and its positive impact on broader company performance. Not surprisingly, changes related to DEI are at the fore now. The inequalities laid bare by COVID-19 and the groundswell of support for social justice movements have propelled issues of diversity and inclusion to a front-and-center position at companies. The sensitivity toward equality and fairness has been growing over recent years, and the demand for a more inclusive society is hitting a crescendo. In parallel, there is a significant and still growing body of research that links diversity to improved profitability, better employee retention, and lower investment risk. Yet, within financial services, for example, the landscape remains largely unchanged. The lack of diversity in key decision-making roles persists despite the acknowledgement that diverse groups –represented by people with different perspectives, backgrounds, and experiences – reach decisions that more broadly examine all sides of an issue. But the concepts of diversity and inclusion are about so much more than better performing organizations. They build resilience into the fabric of our economy and lead to better outcomes for people, society, and the planet.
With this Paradigm Shift in investing, asset management firms are going to need to think like technology disruptors and innovators, not monolithic organizations clinging to past beliefs no longer relevant in a dynamic global economy. To recognize (or better, predict) the far-reaching effects of swiftly changing views on DEI, successful companies must themselves have empowered diversity within their ranks – nowhere is this truer than asset management.
Capital markets participants must transition from passively abiding change to playing a lead role in driving purposeful outcomes that serve society and developing enduring businesses that thrive by balancing the needs of all stakeholders. To do this, welcoming historically underrepresented groups is not only a benefit, but a necessity if we are to successfully navigate the changing landscape.
TECHNOLOGY AND DATA
The speed of technological innovation is staggering, and its permeation through the economy is such that most sectors are now de facto technology driven. As individuals, our lives are permanently altered by the rise of social media and the emergence of the ‘digital person’ –one’s online identity. Access to technology and fluency in technology use are key determinants of economic success, for individuals, companies and even countries. Profound and real change, when it comes to technology, is undeniable. Data, for its part, is changing, too. Access to data has increased dramatically in tandem with access to technology, but it is the speed at which data circulates that is truly mind blowing. Pair this with the now-decentralized nature of data creation, and it is no surprise that data accuracy (or more generally, information accuracy) is a key concern as the Paradigm Shift takes hold.
The asset management industry is a case study in how technology and data are dramatically altering the way investing is done. New tools like natural language processing allow for the ability to extract insights from text-based sources. Artificial intelligence more generally can help bring order to the enormous volume of unstructured data generated daily. With the velocity of ‘news’ and the rise of social media, companies have nowhere to hide, bringing a heightened awareness of public perception to management, and often swift reactions on the part of investors. New data sources emerge with increasing regularity thanks to decreasing barriers to entry and the lure of lofty licensing fees. While new data and new technology are not without their own potential pitfalls, we believe that investors who embrace cutting edge technology and alternative data will have an advantage given the inherently competitive nature of investing. In a world in which basis points matter, access to data and – most importantly – the ability to find actionable information within data is a must.
THE NEW STAKEHOLDER PARADIGM
These three changes upon us now – things that really are different this time – are new enough, swift-moving enough, and unsettled enough that we have far less certainty about their possible paths of travel when compared to the more ‘known’ challenges in equity market investing. Those who remain deeply wedded to the belief that we will return to some now-dead version of ‘status quo’ that existed before ESG, or the push for diversity, or artificial intelligence, will be fumbling to make sense of what comes next. Equally disadvantaged will be those who find themselves within a cumbersome bureaucracy – they may actually have the desire to embrace change but not the practical ability.
What these three changes, and the demographic shifts that are propelling them forward and amplifying their influence, have in common is that we have not seen them before in any meaningful way. But the silver lining is that big changes, no matter how jarring, can open us up to new ways of thinking and acting; they force us to find new solutions and contemplate new opportunities. The investment firms that will succeed in this Paradigm Shift—what we call the new Stakeholder Paradigm—are those who are best positioned to understand the expectations and requirements of new constituents and nimble enough to pivot in a way that allows them to be the architects of their own destinies, as opposed to being backed into a corner by changes they don’t understand or are unable to address.
At Radiant, we believe that trying to play catch-up instead of proactively leading the way will result in poor outcomes for investors. It is time to understand and embrace what is fundamentally changing. To thrive in the new Stakeholder Paradigm – a new era for investing – will take a different approach and a different type of firm. Radiant is committed to an investment practice that acknowledges the ‘rough seas’ of equity market investing, but simultaneously welcomes the true evolutionary (even revolutionary) changes that are happening now as we shift to a stakeholder orientation, a more inclusive economy, and a faster-paced, decentralized data and technology environment. These changes, collectively, have the potential to make us better investors and better stewards of our clients’ capital. We can better reflect the constituents we serve and commit to new ways of thinking and nimbleness in our investment process, in our use of technology, and even in our organizational structure.
Radiant is prepared and excited for the new Stakeholder Paradigm—the result of which will be to drive positive change in environmental, social and governance issues and positive progress on diversity equity, and inclusion efforts, while furthering advancements in data and technology to accelerate progress and ensure accountability.
We believe it will be a bright future for investing, but it will take a truly differentiated asset management firm to succeed.
 In reports published in 2018 and 2019, Cerulli Associates projected that, over the next quarter century, more than $68 trillion will changes hands in the US, with the majority going to Generation X and Millennials. https://info.cerulli.com/rs/960-BBE-213/images/2020-The-70-Trillion-Dollar-Opportunity.pdf