NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, December 20, 2016

Jon Lukomnik is one of the pioneers of modern corporate governance. He cofounded the International Corporate Governance Network (ICGN) and GovernanceMetrics International (now part of MSCI), and served as interim chair of the Council of Institutional Investors’ executive committee. He serves as executive director of the IRRC Institute, which funds corporate governance, sustainability and capital market research. A three-time recipient of the NACD’s Directorship 100 award, he has also been honored by the ICGN, Ethisphere, Global Proxy Watch and others. Jon is a member of the Standing Advisory Group of the PCAOB, and his new book, What They Do With Your Money: How the Financial System Fails Us and How To Fix It, coauthored with Stephen Davis and David Pitt-Watson has been widely praised.

Christopher P. Skroupa: Jon, you recently identified two developments at the nexus of investing and sustainability, one of which you dubbed ESG (environmental, social, and governmental criteria) 2.0 and the other systems level investing. Can you explain how they differ from old-style SRI (socially responsible investment) or impact investing?

Jon Lukomnik: Let’s take systems investing first, because it’s a phenomenally important investment paradigm that is only now being understood. Under modern portfolio theory, the biggest determinant of the return on your investments is “the market.” But despite the fact that the market’s return determines more than 90% of the variability of your portfolio—much more than which stocks or bonds or other securities you select—modern portfolio theory says it’s exogenous to your investments. In other words, if you just use portfolio theory, you think you can’t affect the overall market and just have to agree to be buffeted by its cross-currents.

In the real world, we know that’s not true. For example, “Risk on/Risk off” markets are caused by investors moving their money. More narrowly, CalPERS changed the market return of the Philippines equity market by getting the laws there that affect foreign investors changed. In fact, Steve Lydenberg, Bill Burckart and Jessica Ziegler of The Investment Integration Project recently issued a great report showing how 50 major institutional investors deliberately try to influence the financial, environmental and social systems so that their investments can thrive.