Al Gore has become a salesman, in the latest iteration of his career—and what he’s selling doesn’t emit carbon, dig up blood diamonds or cause cancer.
Gore’s shiny new product, as detailed in the November issue of The Atlantic, is created by a company called Generation Investment Management. It puts $12 billion worth of client money to work in ethical ways, and has managed to generate handsome returns.
The article presents Generation as having discovered the holy grail of investing, where enlightened investors earn big, green, socially-conscious profits. That’s a rare feat. After all, ethical investing has been around for quite some time, but up until now it has rarely if ever presented itself as a means of generating excess investment returns. And yet, here’s James Fallows in The Atlantic:
The message [Gore] hopes Generation’s record will call attention to is one the world’s investors can’t ignore: They can make more money if they change their practices in a way that will, at the same time, also reduce the environmental and social damage modern capitalism can do.
A certain amount of skepticism is warranted here. After all, Generation was co-founded by a political celebrity and a former Goldman Sachs executive, and it operated under a veil of secrecy for more than a decade before opening its curtains a tiny bit for a brace of magazine profiles. They’re controlling the narrative, and they’re not exactly being fully transparent.
First: What kind of returns have Generation’s investors seen? Two different third-party firms have attested that Generation’s main fund has delivered a 12.1% return over 10 years. What we don’t know, however, is how much the fund returned over other time periods: are they only going public with this figure now because they’ve finally arrived at a number which looks good? And, more importantly, how much of that 12.1% was eaten up by Generation’s fees? No one’s saying.
Secondly, are Generation’s returns just a single interesting datapoint, or, as Fallows implies, has Al Gore’s new company managed to find a model which can be replicated, or at least scaled? This is the multi-trillion-dollar question, since standard finance theory says that while it might be possible to find an edge, in investing, it’s much, much harder to keep that edge once people have found out what you’re doing.
Generation’s outperformance to date is plausible. While $12 billion is a lot of money to an individual, it’s only about 0.02% of the $69 trillion invested in stock markets, and 0.004% of the $294 trillion in total financial assets. It’s small enough to be able to do two things which couldn’t happen if its strategy were adopted more broadly: it can find attractive investments in small companies which are still big enough to boost its overall returns; and it can buy near the market price, without its own purchases moving the market against it. But already there are signs that Generation has got about as big as it can get, on those fronts: small as it is, the company has stopped accepting new money in its main fund.
So while Generation has made good profits in the past, and might well continue to make good profits in the future, it’s not clear that its model can scale. To put it another way: Looking at Generation can tell you interesting things about Generation. But it probably doesn’t tell you anything particularly interesting about ethical investing more generally. And it certainly doesn’t mean that Al Gore has managed to reinvent capitalism as we know it, or that he is the next Warren Buffett.
Thirdly, just how different, or revolutionary, is Generation anyway? What does Generation do that other fund-management companies don’t?
Here, James Fallows has lots of gushingly positive things to say about Generation’s techniques of looking at companies in depth, thinking broadly about the direction the world is moving in, holding stocks for long periods of time, paying employees based on three-year returns rather than how much their stock picks went up that quarter, and the suchlike. He quotes David Blood, Gore’s co-founder, as saying that “we are making the case for long-term greed.”
But the idea of being “long-term greedy” is hardly new: in fact, it has been the unofficial motto of Goldman Sachs for a good 50 years now. (The phrase was coined by legendary Goldman executive Gus Levy in the 1960s.) It’s also no coincidence that before he co-founded Generation, Blood made his fortune running Goldman Sachs Asset Management (GSAM), along very similar lines to the ones Fallows describes seeing at Generation. What’s more, he has brought a number of his GSAM colleagues along to Generation with him.
For people who were following GSAM in David Blood’s day, Generation’s stock-picking techniques sound very familiar indeed—even down to rating companies on a five-point scale for various different attributes.
The biggest difference between Generation and GSAM, it seems, is that rather than look at every single company in the world as a potential investment, Generation confines its analysis to a smaller universe of companies. The result is that it can do more in-depth analysis with fewer employees. As in so many other areas, constraints can be helpful.
Generation, in this sense, is like any other outperforming mutual fund which concentrates on a single sector, say telecommunications stocks or micro-caps. When those funds do well, it’s often thanks to a deep understanding of the stocks in question, rather than being a function of the sector as a whole being a Good Place To Invest in perpetuity.
The stock market has always had fund managers who try to gain an edge by researching companies in more depth than the competition. Sometimes, those managers are successful, at least for a while. But the model isn’t an easy one to pull off. It’s based, after all, on attracting quite a lot of the kind of super-smart, highly-qualified analysts who don’t come cheap. (Generation has 17 analysts working for its global equity fund alone.) What that means is that before you do any kind of stock picking at all, you need to find investors who are willing to pay premium fees for your service.
This, it seems to me, is really where Generation has managed to distinguish itself: between Blood’s track record and Gore’s Davos-man salesmanship, the firm has successfully built up an investor base which is willing to pay a premium for the Generation model. That’s also Generation’s real edge: while anybody can attempt smart analysis, many fewer people have the kind of access that Blood and Gore do to the world’s ultra-rich individuals and institutions.
Finally, and most importantly, comes the biggest question of all: Is ethical investing in general a smart thing to do from a financial perspective? After all, Generation is a relatively small fund, which is closed to new money, and only works with clients who have at least $3 million to invest. There’s not much point in taking an in-depth look at Generation unless you think it points to a bigger truth about the kind of returns you can get by using an ethical screen to limit the range of companies you invest in.
To answer that question, you need a model: an intuitive explanation of why ethical investment should outperform. The Generation thesis is that when companies pay serious attention to environmental, social, and corporate-governance factors, it has a positive effect on their profitability and long-term success. If you’re investing with a long term time horizon, then you don’t particularly want to put your money into companies that are going to make a lot of money tomorrow. Rather, you want to look for companies that will have happy and productive relations with their workforce for many years to come; companies that will be able to provide solutions to the problems posed by global warming; companies whose business models are sustainable in all senses of the word. Finding those companies isn’t necessarily easy, but once you’ve found them and invested in them, you should be able to sleep pretty well at night, in the knowledge that they’re likely to be making money even as the world changes in profound ways.
There’s another reason why ethical investing might outperform, which is that people who work for ethical companies are more highly motivated. Alex Laskey, for instance, the CEO of Opower, which Generation owns shares in, says that’s a key driver of profits for his company:
Employee quality is higher in companies that are mission oriented. We attract more talented and passionate employees because when they come to Opower they know that not only do they have the opportunity to make a lot of money and solve difficult and challenging problems, but because they know that they're going to be a part of something bigger than themselves. Our employees work harder and with more pride because they know they're working to help the power industry transform itself… That pride is a productive force.
As Deutsche Bank CEO John Cryan says, “I have no idea why I was offered a contract with a bonus because I promise you I will not work any harder—or any less hard—in any year, in any day, because someone's going to pay me more or less. There is no behaviour of mine that is driven by this contract, so I don't see how it's relevant.”
This is true in finance, at companies like Deutsche and Generation, where it’s very easy to see that a demoralizing cash-first culture could be counterproductive (exhibit A: the global financial crisis), while a more mission-driven culture could cause a team to really come together and excel. But it’s probably true more broadly, too. It stands to reason that if you’re proud of what you do, and if your company treats you well, then you’re going to end up doing better work, and your company is going to reap the benefits.
So, can normal people invest ethically, or is this space only open to Generation’s gazillionaire investors? The good news is that there are some alternatives for the little guy who can’t invest in Generation.
A company called Aspiration, for instance, has just launched the Redwood Fund, which charges a low flat fee of no more than 0.5% per year, all of which goes to outside expenses, and then works on a pay-what-you-want model as far as its management fee is concerned. The goal? “A fossil fuel-free fund investing in sustainable businesses that are leaders in their industry when it comes to caring about their people, the planet, and their company's purpose and mission.”
It’s a noble mission, and it’s open to anybody, with a minimum investment of just $500. Maybe it’s worth a try.