Sunday Brunch: what do asset managers really care about?

Understanding how asset managers think about investing, and what goes into their portfolios, is fundamental to how we can encourage them to think and act differently about sustainability. What they care about might be very different from what you expect.

At the risk of ruining the 'surprise' I argue (based on both experience and research) that they care the most about beating the index. Which means they have to 'know' something different than the market as to the future of the company. Which means that they may be more open to discussions on sustainability than you might think.

Sustainability is likely to bring fundamental changes to many industries'. And for all sorts of reasons (the topic for a future blog) these changes are not being properly priced in by the market.

I want to be clear, this is not a technical blog about portfolio construction, or an examination of the question 'is the market short or long term' in it's thinking (it's long term despite what you might have read). It's about what it is we as clients (asset owners) are asking the asset managers who look after our money to actually do. And how that impacts the way they think about sustainability.

I have wanted to write this blog for ages, I just have lacked a good (recent) research report to anchor it to. And then along came this really good paper from Michael Mauboussin & Dan Callahan at Morgan Stanley. This is an update on a 2019 report which starts with "being successful as an active investment manager requires seeking, finding, and capitalizing on inefficiencies in the market.'

I want to gradually unpack what this means for a non financial sustainability focused audience - ending with some thoughts on what this means for how we engage with asset managers on sustainability issues.

Let's start right at the beginning.

Most people think that successfully managing an investment portfolio is about 'finding' undervalued (ie cheap) investments. And the measure of success is - does the value of the portfolio go up. As with most things in finance and investing, this view is only partly right.

Let's try a simple thought experiment.

Let's say you manage an investment portfolio, and you have generated a financial return for your investors of 10% pa. If we assume that they are only care about financial return, have you been successful? The answer to that question depends on what return they might have got putting their money into an index product with a similar risk, say the S&P 500 or the Nasdaq.

In 2025 (according to US500) the S&P 500 delivered a financial return of 17.88%. And over the last 5 years the return was 14.4% pa. This is before fees, but the cost of an S&P 500 index product will not shift this very much.

So your 10% return now doesn't look that great. And as a consequence your investors have probably already withdrawn their money from your fund and put it to work somewhere else.

Which means that what most asset managers really care about is beating the index. This is really hard. And more importantly for sustainability, it subtly changes what makes a good investment.

If the financial markets are mostly efficient (which the evidence suggests is true), what asset managers really want to find are investments where they have a different view from the market.

Let's go back a step. An efficient market means that the market price already incorporates all publicly available information. So the share price of the investment you are thinking about already incorporates all of the known information about that company and it's markets. At least at that point in time.

And so if financial markets are truly efficient, the only way you can make above the market rate of return is if you 'know' something that the wider market does not. Which brings us back to why asset managers and other investors really care about what the market thinks about an investment idea.

Who is on the other side?

What do Mauboussin & Callahan mean by this phrase? For every buyer of a share there is a seller, and vice versa. So if you are buying, you obviously have a more positive view of the companies future than the seller. And given that share (equity) markets are mostly efficient, almost by definition you are also taking a different view from the market. Why - because at the time you buy the share the share price reflects all available information.

The report goes on to describe three main ways that you might have an edge over this efficient market. First, you could be exploiting behavioral inefficiencies. This is where human nature causes investors to have blind spots that mean that share prices can be 'wrong'. One blind spot that some investors seem to have is around climate change and it's impact on companies.

Second, you could be better at analysis. You have the same information as everyone else, but you are better at working out what it might mean for a future share price. This is includes the analysis of non financial information (such as sustainability changes).

And third, you could have better information. By that we don't mean inside information. It could just be information that is expensive or difficult to collect.

Hopefully you can see how these inefficiencies apply to sustainability. It could be that a significant number of investors don't see climate change (or other sustainability changes) as being material for valuation. They might therefore ascribe a higher value to a company share, and so they would make a good target for short selling. Or it could be that they don't properly use non financial information when they evaluate a companies strategy or barriers to entry. This might lead them to identify a lower value for a companies shares. In which case they would be willing sellers to you, at below 'fair value'.

And if you are engaging with investors on sustainability issues, you can also leverage this inefficiency. If you can persuade them that a sustainability related issue might move the share price in the future, then they would be encouraged to prepare for such an event. Including changing how they invest.

Note I say might, not will move the share price. The future is not knowable, and so just introducing an alternative scenario can shift the consensus view.

I really encourage sustainability professionals to read the report, it could change the way you think about investing, and how you engage with investors. If you have trouble with the link, just let me know and I can send you a copy.

One last thought

For a company sustainability can be like a good brand (what we call an intangible asset). Without it your business can lack the quality that gives it a viable long term future. Intangibles may be invisible, but it doesn't make them any less real. And they can be source of future earnings surprises.

Sunday Brunch: sustainability is an intangible asset

Sustainability can be like a good brand. Without it your business can lack the quality that gives it a viable long term future. Intangibles may be invisible, but it doesn’t make them any less real.

The Sustainable InvestorSteven Bowen

Grant me the strength to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference. Reinhold Niebuhr - a Lutheran theologian in the early 1930's

Please read: important legal stuff. Note - this is not investment advice.