Recently, the field of responsible investing has been debated and challenged on its effectiveness in terms of real-world impact(1,2).
While the finance community at large agree on the premise of responsible investing, its ability to influence markets and direct capital flows in a more sustainable direction, the supporting evidence diverges across different strategies. For example, as Jon Hale at Morningstar recently noted, driving up companies’ cost of capital based on capital flows is currently more a theoretical implication, yet to establish a stronger link(3). Moreover, academic researchers Julian F. Kölbel et al(4) found that investors can directly influence companies through shareholder engagement, but only indirectly through capital allocation impact unless targeting for example markets where external capital is a limiting factor. Another study by Marco Ceccarelli et al(5) found that leaders - identified as institutions that lead and support separate collaborative engagements via the PRI during a given year - alone explained the positive relationship between institutional ownership and firms’ environmental and social performance. And even if the evidence was not enough to demonstrate a causal effect of Leaders on corporate sustainability, the authors note that while the majority of institutional investors advertise a commitment to sustainability, only a minority positively drives corporate sustainability.
Today, from an economic systems viewpoint, so-called mixed economies predominate because of the blend of markets and government. These economies are regulated by governments to correct market failures, such as pollution. And even if capitalism has underpinned increased economic prosperity and social welfare, societies face many market failures, or systemic ESG challenges if you will, such as climate change, biodiversity loss, and poverty. Still, we don't have a global price on carbon, fossil energy exploration and deforestation continues, and the respect of human and labour rights has declined during the pandemic, with a lot of work still needed on for example regional and jurisdictional adaptation of the decade-old UN Guiding Principles on Business and Human Rights(6).
The situation we find ourselves is driving the shift towards stakeholder capitalism and has resulted in the mainstreaming of ESG. However, there should be no question around how this promise of responsible investments has benefitted many, monetarily speaking. Just take a look at the inflow of capital to ESG or RI labeled strategies over the last decades, the growth has been nothing but staggering. Recognizing that it does require effort and budget spend on ESG research, human capital, technical infrastructure, and so forth - concurring with an overall downward pressure on fees and margins -, analysis has shown that these funds historically have incurred higher fees (7, 8, 9)
The ripple effect of change
Status quo evidently does not provide for the progress or urgency needed to reach the UN 2030 agenda or the Paris accord. In order to break through the noise, you need a critic(10) who provides a stance in stark contrast to common perception. This is often an ungrateful position to take, but arguably an important one as it spurs discussion, and creates a ripple effect functioning as a change agent. As in most instances though, we seldom find the answer to be either black or white, but rather unfolding over a spectrum.
A way forward
There is no doubt that responsible investing at least functions as a norm influencer in secondary markets. The role of engagement and impact investing (in otherwise capital-constrained companies) need therefore to be recognized as primary drivers of change. And yes, there are also valid criticisms of engagement: Some investors claim active ownership without a well-structured process and far from responsible activity levels, which results in a lack of tangible progress, and engagement essentially being used as a greenwashing mechanism.
Increasing stewardship commitments, especially around collaboration and support of public policy (11, 12), should be a prioritized objective to help transform societies and meet evolving fiduciary duties globally (read: investor responsibilities)(13, 14). And while I fully agree with the notion that responsible investing, in general, is accentuating the need for policy intervention and not the other way around, doing more is frankly what should be demanded of us if we were truly serious about our values and intent.
Listen to the podcast 'Grow the Pie: does ESG investing work? How?' with Alex Edmans and Tom Gosling where they partly discuss evidence on the real-world impact of different ESG investment approaches: shorturl.at/xBIN9
Author: Rickard Nilsson, Director, Strategy & Growth @ Esgaia Rickard is passionate about all things esg, especially investment stewardship and how engagement can help advance sustainability practices. With years of experience in responsible investments, in his role at Esgaia, he focuses on market intelligence and outreach, and promotion of industry best practices.
10) https://medium.com/@sosofancy/the-secret-diary-of-a-sustainable-investor-part-1-70b6987fa139 11) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3988058