Some institutional investors might dismiss “inclusive capitalism” as a warm and fuzzy political slogan.
But Brexit, which few in the establishment saw coming, highlights fissures between those who benefit from the openness of borders and the flow of people, know-how and trade across them, and those who see their wages stagnate and prospects appear to narrow amid an arrival of people from elsewhere that alters their neighborhoods, their schools, and the economic and cultural landscape. Some voters, including the younger and more urban, might embrace such phenomena as the world they’ve always known, but others perceive a threat to their way of life.
Though the aftermath of the vote may leave investors scrambling to make sense of gyrations in markets, the undercurrents of this schism have unfolded over the long term and could continue to impact portfolios in a range of ways.
For many long-term investors, integrating environmental, social and governance (ESG) analysis into their investment process is aimed not only at identifying poor corporate behavior or gauging management quality; it also increasingly reflects the importance of understanding a fuller set of portfolio-related risks that include large-scale social and environmental trends playing out over longer horizons.
Inequality – the “haves versus have-nots” – has gained relevance for some investors as these tensions continue to cohere in the political arena. Few companies (and arguably few investors) anticipated the swiftness with which regulators have closed loopholes in tax laws, raised minimum wages, or required disclosure of disparity between the pay of CEOs and workers. Analysis by MSCI ESG Research shows that the real estate industry’s focus on the high-end market creates a crisis of affordability for households in the middle.
In each of these instances companies maximize their advantage, but, collectively, those individually rational choices create socio-economic pressures that can trigger system-wide dislocations.
The undercurrents can result in risks to asset prices across multiple asset classes over the longer term. Our analysis of ESG risks facing government bonds points to an upswing in vulnerable employment and possible dislocations in labor markets that arise from rapid economic, social and technological change. The risks of Brexit may extend beyond immediate consequences for trade and investment and include impacts on human capital, social stability and demographic risk.
While it is difficult to predict extreme political and social events, it is possible to build models to test a portfolio against potential shocks. Some investors have indicated to us the importance of factoring the consequences of inequality and popular discontent into their view of risk. Their next logical step could be to incorporate those views into a structured program of scenario testing.
Many of the policies espoused by politicians across the political spectrum share characteristics of populism, including opposition to trade agreements, support for government spending and isolationist foreign policy. In coming weeks, MSCI expects to incorporate ESG research on the underlying drivers of populist sentiment into our macroeconomic modeling capabilities to provide tools to help examine the potential outcomes of these scenarios.
When Stress Tests Become Reality: Which Scenario after Brexit?
How Brexit May Impact Your Portfolio
Looking more closely at intra-corporate pay gaps
Re-Examining the Tax Gap for MSCI World Companies
The Crisis of Affordability in Real Estate