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Sustainable Investing: Do you want a green place to start putting…

(MENAFN – The Conversation)

So-called sustainable investment funds make a staggering list of promises, including higher returns, lower risk, fighting climate change and even supporting diversity. And many believe them: investments in ESG (environmental, social and governance) funds are on track to exceed £34 trillion by the end of 2022, nearly double their £18.4 trillion. pounds in 2016.

But sustainable investing has also drawn heavy criticism. Former BlackRock head of sustainable investing Tariq Fancy called ESG a “dangerous placebo,” and the Wall Street Journal published a week-long series of rebuttals of the trend, along with their feature article. opening titled “Why the Sustainability Investing Craze is Flawed”.

Whichever side you take, you have incentives to make your claims extreme. Asset managers promising that their ESG funds will save the world see new companies flood in and are heralded as the saviors of capitalism. Critics have also become famous as self-proclaimed whistleblowers who uncovered a financial scandal.

If you’re a first-time investor trying to decide where to put your money, it can be hard to know who to believe. So if we strip away the hyperbole and look at the evidence, is sustainable investing worth the hype? To answer this, we’ll look at the three objectives investors have when buying ESG funds.

This article is part of Quarter Life , a series about issues affecting those of us in our 20s and 30s. From the challenges of starting a career and taking care of our mental health, to the excitement of starting a family, adopting a pet or simply making friends as adults. The articles in this series explore questions and provide answers as we navigate this turbulent time in life.

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Does sustainable investing bring in more money?

The first objective is, unsurprisingly, financial. Investing in sustainable businesses will increase your returns and avoiding unsustainable ones will reduce risk. Industries like electric cars are the future of transportation, while corporate dumping of fossil fuels means you’re sheltered from a carbon tax.

There is evidence that some dimensions of ESG pay off. One of my studies finds that companies with high employee satisfaction, a “social” dimension, outperform their peers by 2.3% to 3.8% per year in shareholder returns over a 28-year period. year. Other research finds higher returns for companies with superior governance and those that link CEO pay to performance.

But the ESG suffers from confirmation bias. Since we want to believe that ethical companies perform better, we cling to studies that say so, even if the evidence isn’t so strong.

This highlights how the financial case for sustainability depends on the ESG dimensions you consider. Every day, catchy articles insist that “investing in ESG pays off”. But asking whether ESG helps or hinders returns is as futile as asking whether food is good or bad for you – it depends on the food.

Does sustainable investing change corporate behavior?

The second objective is the impact of the fund on corporate behavior. Divestment campaigns aim to induce shareholders to sell the shares of certain companies and dissuade new investors from buying them. By divesting (say) the fossil fuel companies, the argument goes, we deprive them of capital and prevent them from creating more pollution.

But investor boycotts don’t deprive a fund company, because you can only sell if someone else buys. They are very different from customer boycotts, which deprive a business of revenue.

Maybe divestment doesn’t immediately unplug a company, but does it make it harder for them to sell stock in the future? Not necessarily. “Brown” companies like fossil fuels and tobacco don’t raise a lot of capital to start with – they are yesterday’s industries with few opportunities for growth. And evidence suggests that the cost of raising capital has little effect on business expansion.

Consumer anger at the exploitation of fossil fuels is growing. John Englart/Flickr, CC BY-ND

Stock price can matter for many reasons other than the cost of capital. Even if a company doesn’t raise capital, a low price hurts the CEO’s reputation and demotivates employees. But if so, my research suggests that the best strategy is actually to tilt (move away from a “brown” sector but still be willing to own leading ESG companies in that sector ), not exclusive (avoid this industry altogether).

If a fossil fuel company knows it will be sold no matter what, it has no incentive to develop clean energy. But if his shares will be bought if he leads his sector in sustainability, that motivates him to clean house by investing more in reducing emissions.

Many accuse ESG funds with holdings in brown industries of hypocrisy and praise those that won’t touch a struggling sector like oil, but the reality is far more nuanced. And owning brown businesses is the only way to hold them to account. Investment firm Engine No. 1 is famous for appointing three climate-friendly directors to Exxon’s board because it owned stock in the company.

Claiming you’re a true sustainable investor because you only invest in green businesses is probably like a doctor singing that all his patients are healthy – when that’s a doctor’s job. to care for the sick.

Is sustainable investing the right thing to do?

The final motive is moral: you believe it is morally right to invest in certain companies. For example, even if diversified companies do not perform better, it is reasonable to invest in them as an expression of your values.

Diversity is an ESG dimension. WOC In Tech Chat/Flickr, CC BY-ND

But identifying “moral” companies is difficult because many key dimensions of morality are difficult to observe. A company might put minorities on its board to tick the diversity box, but do nothing to create an inclusive culture.

So, is sustainable investing worth the hype? It has the potential to improve performance, but only if you focus on particular dimensions. It can change business behavior, but through tipping and engagement rather than exclusion. ESG is neither the panacea claimed by proponents nor the scandal claimed by detractors. But the shades of gray are lost in the shadows if you only look for black and white.

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