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ESG investing is more than blacklisting companies

Jon Hale  |  12 Jul 2018Text size  Decrease  Increase  |  
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Protest against gun violence in United States

The world of environmental, social and governance (ESG) investing was lit up in January when the head of BlackRock, the world's largest asset manager, urged CEOs to think long term, benefit all their stakeholders, and make a positive contribution to society. Fink was not urging them to make less money, he was urging them to position their businesses for long-term profitability by keeping their focus on a bigger picture that includes the role of the corporation in society.

Companies focused on minimising negative environmental and social impacts and accentuating positive ones will be rewarded by increasingly aware customers, will protect their brand, and will attract top talent, enabling them to better navigate the transition to an increasingly low-carbon and digital economy.

The letter generated a lot of attention, but to me it was a one-sided debate. Who's for short-termism? Who's for ignoring stakeholders at a time when global capitalism clearly needs to be made to work for more people? Who's for not taking issues like climate change, diversity, and data privacy into account in corporate and investment decision-making?  

A few investors tried to counter by using Milton Friedman's nearly half-century-old exhortation that profit maximisation is what business is about, not social purpose, by which they assume any corporate spending for social purpose is value-destroying because it has nothing to do with the business itself.

But Fink's argument transcends that one. Social purpose is an investment in long-term profitability. I don't know of a single corporate CEO who spoke out against Fink's letter. Sustainable investing gives them the space they need for bigger-picture thinking.

Not all about blacklisting

Whether or not a fund invests in gun manufacturers or gun retailers can lead to some confusion about whether that is part of sustainable investing, but the Parkland tragedy in February sparked a lot of investor interest in understanding what kinds of objectionable companies are in portfolios, particularly those of passive funds.

Although many sustainable investing funds still use negative screening and many exclude guns, the focus today is on using environmental, social, and governance criteria to determine what companies are best positioned to adapt to a changing world. It isn't inherently about automatic exclusions.

Nonetheless, many fund investors were disappointed to find out that their index funds contained gunmakers or retailers that sold guns, and that there was little they could do about it.

That prompted BlackRock, for one, to engage with those companies, which likely played a role as several retailers agreed to limit or end their sales of guns – although direct public pressure and concerns about reputation may have been bigger influences. BlackRock also announced that gun retailers would be excluded from all of its ESG funds, nearly all of which are iShares exchange-traded funds.

After Parkland, more investors and advisers were confronted with the fact that inexpensive passive portfolios contain some uncomfortable holdings, opening the way for more to consider investing in sustainable funds, and that asset managers running passive portfolios nonetheless need to actively engage with companies they own. That is one way to address investor concerns while at the same time driving shareholder value in companies they'll own over the long-run.


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Jon Hale, Ph.D., CFA, is Morningstar's US-based head of sustainability research. A version of this article was originally published in the January 2018 issue of Morningstar FundInvestor.

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