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What the Wall Street Journal missed about sustainable investing

Jon Hale, Ph.D., CFA  |  01 Feb 2022Text size  Decrease  Increase  |  
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I suppose it's a sign of success when The Wall Street Journal sees fit to launch a weeklong critique of sustainable investing. After all, the Journal is one of the world's chief defenders of the status quo, which, in this case, is the shareholder primacy view of capitalism that is supported and enabled by traditional investing.

The world is moving away from all that, as I wrote last week in discussing BlackRock chair Larry Fink's annual letter to CEOs. Instead, it's turning toward stakeholder capitalism, which is supported and enabled by sustainable investing.

"Everyone is holding business to a higher standard," begins a recent Accenture report, "Shaping the Sustainable Organization," about how corporations can "create lasting value and equitable impact for all stakeholders."

People want to work for sustainable companies that treat them well and have a positive purpose. Nearly two thirds of employees in a survey conducted for the Accenture report said businesses should be responsible for leaving their people "net better off" through work.

When making consumer purchases, people now more often consider the sustainability of the product and ethics of the company making it. Nearly three fourths of consumers said in the survey that they believe "ethical corporate practices and values are an important reason to choose a brand," and two thirds said they "plan to make more sustainable or ethical purchases in the next six months."

So people-as-workers and people-as-consumers want to hold business to a higher standard. What about people-as-investors? When Morgan Stanley asked individual investors about their interest in sustainable investing in late 2020, 79% said they were interested, and among an oversampled group of millennials--this is not a typo--99% said they were interested. Flows into sustainable funds in the United States and Europe continued to set records in 2021.

Sustainable investing is hardly a "craze," as The Wall Street Journal headline called it. Crypto is a craze; SPACs are a craze; day-trading meme stocks during the pandemic is a craze. Sustainable investing is part of a long-term shift in the way people approach their investments, and it is helping bring about a systemic shift toward stakeholder capitalism. In so doing, at a time when governments are hamstrung by a variety of limitations in addressing problems like climate change and growing inequality, sustainable corporations can step up to play a greater role. Large corporations are, after all, enormously influential institutions globally.

And what about people-as-citizens? In perhaps the most disingenuous claim made by Journal author James Mackintosh, he says, "My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidise the things we think are good."

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Seriously? First off, in the U.S. anyway, navigating our broken dysfunctional political system is hardly a "simpler" path to take for effecting change. Second, sustainable investors can walk and chew gum at the same time. Both in their role as investors and as individual citizens, they can and do support public policy solutions to address problems like climate change. No one is saying, "Let's just fight climate change as investors so governments don't have to." No one is saying, "I can't be distracted by politics because I'm too busy with my sustainable investing."

Policymakers are hardly going to ignore issues like climate change, improving diversity in the workplace, and strengthening democratic institutions because sustainable investors are growing in number and are concerned about these issues. The fact that so many investors, from individuals to institutions to asset managers, are showing such high levels of concern over sustainability issues provides greater impetus for policymakers to act, not less.

Let's take a closer look at three "pro-ESG arguments" that Mackintosh thinks "sound reasonable, but have major flaws." First, is the big picture move toward stakeholder capitalism, discussed above. Mackintosh's view is that companies focused on creating value for all their stakeholders will ultimately just take on added costs, which will lead to reduced investor returns. This represents a difference in philosophy, the old way of looking at it, which assumes that addressing ESG issues is simply about adding costs, rather than about adding value. Indeed, there will be winners and losers as we move into the era of stakeholder capitalism. But examples abound of companies moving in this direction. Those that don't try and those that don't get it--by which I mean those that simply add costs without creating value--will struggle to meet their sustainability challenges, which will hurt their profitability in an era where expectations for corporate performance are much different than they have been over the past half century.

The second pro-ESG argument that has major flaws, according to Mackintosh, is the idea that by shunning investments in "dirty" companies and embracing "clean" ones, sustainable investing can direct capital away from bad companies and toward good ones, driving up the cost of capital for the former and lowering it for the latter. He says this is flawed because there is not much evidence demonstrating this has happened, except perhaps in the case of energy companies. However, this is not really an argument that's central to sustainable investing. It's more a theoretical implication often discussed by academics who have yet to find much of a link. That said, few companies today want to be excluded from ESG indexes, and there is growing issuance of sustainability-linked bonds, which lower the cost of borrowing if the issuer meets predefined sustainability objectives.

Moreover, an academic study just published in the Journal of Banking and Finance found that "decarbonisation selling pressure" does negatively affect the stock prices of divested firms and contributes to the reduction of these firms' carbon emissions.

Finally, Mackintosh highlights the fact that most sustainable funds simply use ESG ratings to try to generate better investment returns, not to try to change the world. The reason he feels the need to point this out reflects the underlying theme of his entire argument--that sustainable investors are hopelessly naive and have been duped into thinking that they can change the world through their investments.

Well, thank you for your concern, but sustainable investors, be they individuals, institutions, or asset managers, are far from naive. They understand better than most the urgency of making progress on major systemic problems by whatever means necessary. They understand that as investors, they cannot behave as though problems don't exist and won't harm their long-term returns. But they also understand that their investments need to generate returns that will help them reach their financial goals. A sustainable investment is an investment first, but that doesn't mean it can't generate positive impact.

One important way that sustainable investing is generating real impact is through direct shareholder engagement with companies about various ESG-related concerns and, when engagement isn't successful, voting in favor of ESG-related shareholder proposals. In the past several years, these efforts have been more successful than ever in pushing companies on a range of sustainability issues, including making net-zero emissions commitments.

Indeed, this year's proxy season in the US began with 70% of Costco shareholders supporting a proposal sponsored by Green Century Funds, calling on the company to set science-based targets to reduce its greenhouse gas emissions.

Jon Hale has been researching the fund industry since 1995. He is Morningstar's director of ESG research for the Americas and a member of Morningstar's investment research department. While Morningstar typically agrees with the views Jon expresses on ESG matters, they represent his own views.

is head of sustainability research for Morningstar.

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