Societal Function of Investment Asset Classes

The societal function of asset classes is a topic currently under-researched in the academic or financial communities, but of considerable potential importance to positive financial, as well as social, outcomes. Institutional investors have long been aware of the importance of asset classes and asset allocation in the management of portfolios. Understanding the financial characteristics of different asset classes contributes to diversification, risk control, and the generation of positive portfolio returns. The financial characteristics of various asset classes and their implications for investment decision making have been thoroughly researched in recent years.

Little research, however, has been devoted to the social purposes of these asset classes, which has limited the understanding of their functions to abstractions in the form of indexes and benchmarks. There is reason to believe, however, that the functions that asset classes serve in their roles in society should be important to investors concerned about the long-term prospects for healthy investments and returns.

Different asset classes contribute in different ways to the establishment and growth of a strong economy. An understanding of these functions help investors favor those investment opportunities within each asset class that maximize their ability to contribute to a vibrant economy. Unless the economy and the individual asset classes within it are thriving, finding specific rewarding investment opportunities will be a continual challenge in the long run.

That each asset class makes a distinct and valuable contribution to society is clear. Cash investments, for example, are useful for stability, predictability, and the strengthening of local communities. Depositors want to be certain that funds deposited in a local bank today will be there tomorrow—and the government takes exceptional steps to oversee the management of these banks and insure the safety of their deposits. By contrast, venture capital promotes innovation and disruptive change in technology and management. Investments are risky, failure is frequent, and the upside in returns and innovative change is substantial. Fixed income investments, which are primarily issued by governments in the form of high quality bonds, are particularly designed to create public goods that the private markets can’t easily fund—education available to all, basic scientific research, public transportation and infrastructure, local and national security. Real estate promotes livable physical environments. Public stock markets allow individual investors to benefit from large-scale enterprise. And so on.

These asset classes are different and have different characteristics because they are designed to serve different functions in society—functions that complement each other and work together to create a vibrant and sustainable economy. Understanding the societal purpose of each asset class can help investors to pick securities within that asset class that enhance its ability to strengthen the economy—and to avoid investments that undercut the purposes of the asset class and weaken the economy. This understanding can also help with asset allocation, in the sense that a client concerned with community development might wish to emphasize cash, one concerned with environmental sustainability might add to a venture capital allocation, or one concerned with the with the strengthening of public goods might be inclined to stress fixed income.

To further discussion on this topic, on October 4, 2012, the Initiative for Responsible Investment hosted a conference entitled “The Societal Function of Investment Asset Classes: Implications for Responsible Investment.” The eight academic papers on this topic examined how asset classes currently manifest themselves in the marketplace and looked at their effectiveness in generating socially desirable outcomes along with appropriate financial returns. The research papers addressed seven different asset classes, and included perspectives from Australia, the Netherlands, Singapore, the United Kingdom and the United States.

The day began with a keynote address from Professor Amar Bhidé of The Fletcher School of Law and Diplomacy at Tufts University entitled “A Call for Judgement: Sensible Finance for a Dynamic Economy,” on innovation, economic growth, and the dangers of the financial system as it currently exists. (PDF: presentation)

The first panel began with research by Rajiv Sharma of the Oxford University School of Geography and the Environment whose paper “Infrastructure: An Emerging Asset Class for Institutional Investors” included contrasting studies of the financial and social implications of the privatization of airports in New Zealand and Great Britain. (PDF: paper, presentation)

Zhiliang Li and Yongheng Deng of National University of Singapore then reported on their research on the financial and societal repercussions of company and government commitments to environmentally friendly real estate practices in Asia in their paper “Towards Sustainable Real Estate Investments: Perspectives from Asian Emerging Markets.” (PDF: paper, presentation)

The second panel included insights from Anna Young of University of Sydney Business School on the implications of two different approaches to the integration of ESG (environmental, social and governance) data into mainstream public equities funds in her paper “Materiality for Whom: Responsible Investment and the Societal Function of Listed Equities.”

Alfred Marcus of the University of Minnesota Carlson School of Management then presented research on “The Promise and Pitfalls of Venture Capital As an Asset Class for Clean Energy,” including observations on how approaches to venture capital investment would need to be modified in order to maximize the financial and environmental returns from investments in clean energy companies. (PDF: paper, presentation)

Then Joshua Humphreys of the Tellus Institute followed with his observations on “Responsible Investing in Alternative Asset Classes: Post-Carbon Portfolio Construction within Planetary Boundaries,” stressing the importance of long-term sustainability concerns to the private equity markets and investment in general.

In the final panel of the day, Matteo Millone of the Maastricht University School of Business and Economics examined “The Social Function of Debt and Equity: A Comparison between Investment Instruments in Emerging Markets,” pointing out how different asset classes (debt and equity) can serve different functions during the evolution of a socially beneficial financial innovation such as microfinance. (PDF: presentation)

Dane Rook of the Oxford University School of Geography and the Environment then looked at the concept of financial and environmental resilience as it is currently playing itself out in the commodity asset class of timber in his paper entitled  “Institutional Investment in Forestry and Timberland: Implications for the Long-Term Resilience of a Multidimensional Asset Class.” (PDF: paper, presentation)

The conference concluded with a presentation by Christoph Biehl, UN Principles for Responsible Investment on how this alliance of asset owners and asset managers is promoting the concept of responsible investment across asset classes in a paper entitled “What Role Does the PRI Play to Facilitate the Social Role of Finance Across Asset Classes?” (PDF: paper, presentation)

Papers

Infrastructure: An Emerging Asset Class for Institutional Investors” Rajiv Sharma, Oxford University School of Geography and the Environment (pdf)

Towards Sustainable Real Estate Investments: Perspectives from Asian Emerging Markets” Zhiliang Li and Yongheng Deng, National University of Singapore (pdf)

The Promise and Pitfalls of Venture Capital as an Asset Class for Clean Energy” Alfred Marcus, University of Minnesota, Carlson School of Management; Joel Malen, University of Minnesota; Shmuel Ellis, Tel-Aviv University, Recanati Graduate School of Management (pdf)

Responsible Investing in Alternative Asset Classes: Post-Carbon Portfolio Construction within Planetary Boundaries” Joshua Humphreys, Tellus Institute

The Social Function of Asset Classes: Microfinance as a Product of Donations, Debt, and Equity” Harry Hummels and Matteo Millone, Maastricht University School of Business and Economics (pdf)

Institutional Investment in Forestry and Timberland: Implications for the Long-Term Resilience of a Multidimensional Asset Class” Dane Rook, Oxford University School of Geography and the Environment (pdf)

What Role Does the PRI Play to Facilitate the Social Role of Finance Across Asset Classes?” Natalie Beinisch and Christoph Biehl, UN Principles for Responsible Investment (pdf)