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A trillion-dollar blind spot for asset managers

The writer is a former global head of asset allocation at a fund manager

Senior asset management executives have a blind spot. It’s one I shared for years. Investment firms across the globe love to trumpet their credentials as responsible capitalists. Their purpose statements speak of things like “contributing to a more equitable world”, “leading by example” and “driving change”. But many also work to directly increase the fiscal capacity of authoritarian states facing accusations of serious human rights violations. The contradiction is glaring once you see it.

Authoritarian states control around $10tn of assets through a mixture of sovereign wealth funds, central bank reserves and public pension funds. Given the global investment management industry looks after $110tn, that is a big number. Only a portion of it is subcontracted to external fund managers, but enough to matter. While working on a state mandate, asset managers effectively become outsourced treasury officials seeking to boost their client’s financial power. In other words, they help authoritarian states around the world to finance aims that can be both repressive and repugnant.

Take China’s sovereign wealth fund CIC, which holds about $1.35tn of assets. With almost two-thirds of CIC’s global investment portfolio farmed out to external asset managers, the Chinese state is on almost every firm’s asset-gathering radar. Likewise, Saudi Arabia’s $620bn Public Investment Fund and the country’s central bank are prominent clients for the industry. Firms compete vociferously to work for these states, just as they do with any other asset-rich autocracy not subject to sanctions.

How do those fund managers, who promote their virtue on environmental, social and governance issues, square that with the findings of a UN report which concluded that the detention of hundreds of thousands of Uyghurs in “re-education camps” may represent crimes against humanity? Or reconcile their ESG aspirations with the murder of journalist Jamal Khashoggi?

To be clear, fund managers downing tools won’t stop torture, extrajudicial deaths or other awful things that some clients are responsible for. At most, denying them investment services might make odious regimes marginally poorer. But refusing to work to enrich governments with bad human rights records remains the right thing to do.

The UN guiding principles on business and human rights directly link firms to their business partners’ activities, ultimately accruing them liabilities for unchecked abuses. UNGPs are a framework that ESG teams deploy when analysing investments. And fund managers commit to them when they join the UN Global Compact — as half of the large investment firms have done.

Over time, UNGPs may gain the status of hard law, for example through the EU’s proposed Directive on Corporate Sustainability Due Diligence. But until then the main legal threat attached to dealing with human rights abusers comes from the risk of financial sanctions — as Swiss banks found when their Russian clients’ assets were frozen. There is also a sound commercial case for managers ceasing to work for totalitarians. First, investment firms need to attract, retain and engage their staff. There are studies aplenty linking purpose to profitability through the medium of staff engagement.

A diagram of a decision tree showing UN guiding principles on business and human rights when faced with direct linkage or complicity with human rights abuse First question: Do I have sufficient influence over the client? Second question: Can I increase influence directly to have sufficient influence? Third question: Can I increase influence through collaborative action? Fourth question: Can I explain the choice to continue the relationship?  Answering yes to any of the questions leads to “Use influence to ameliorate human rights abuse”. Answering no to all of them leads to “Exit relationship”

Second, a healthy culture is of regulatory interest. Companies that limit their prospective talent pool to those with the most malleable ethical codes are more likely to find themselves in hot water. And unless deeds are aligned with words, societal trust can never grow. This was a key lesson that regulators took from the financial crisis.

Third, living by the principles you project is good business. The marginal new client in asset management cares about ESG, as do the bulk of existing ones. And with net outflows the norm across the active investment industry, competition for business is fierce. The result has been an enormous arms race and marketing campaign to show ESG credentials. Firms making money for, and taking money from, authoritarian governments ultimately put their businesses at risk.

Yes, firms will lose revenue when they “off-board” authoritarian clients. But they will gain elsewhere by becoming a beacon for talent, ESG partners of choice and more resilient against regulatory and legislative developments.

Made aware of this blind spot in fund management, and unable to effect change from within, I left the industry last year. Since then I have been developing a set of principles on these issues for asset managers and have been encouraged by the interest of industry leaders in the case for change. It is a debate we need to have.

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