At last! Environmental, social, and governance (ESG) investing has become mainstream. That’s a good thing, right?
According to the Global Sustainable Investment Alliance’s report released in July, global assets under an ESG-related mandate are, as of 2020, about $1 of every $3. That’s $35.3 trillion, and, according to Bloomberg, they may reach up to $50 trillion by 2025. Many in the industry have in recent years questioned how much of that is the growth in products that are merely labeled ESG, and the clever marketing of more than a few new entrants.
Though I am an optimist at heart, as impressive as this growth has been and as much progress as we have made in frameworks and in disclosure, we are collectively falling embarrassingly short of meeting the climate pledges of the Paris Agreement and of contributing substantively to the Sustainable Development Goals. That is why there is a need, more urgent than ever, to pursue investing with the intention to help to solve these enormous issues.
ESG integration is limited in that it does not seek to understand and address corporate impacts on society. For this reason, ESG alone will not deliver the changes we need to see — real business model transformation that accounts for external impacts.
While investing in public equities only buys us a small fraction of the overall shares of a company and does not give most investors an influential seat on the board (as may be the case in private equity), public equity investors can still have an impact.
Shareholder advocacy is the process by which we engage with companies on issues that need to be amplified. The sustainable investing industry has long incorporated ESG criteria to make investment decisions, but ESG integration is not impact. The integration of ESG factors into investment decision-making is clearly a sound risk management approach if it chiefly seeks to identify and minimize portfolio and company exposure to risk. But ESG integration is limited in that it does not seek to understand and address corporate impacts on society. For this reason, ESG alone will not deliver the changes we need to see — real business model transformation that accounts for external impacts.
Given the large social and environmental footprints of publicly traded corporations and their high allocation in most investor portfolios, public equities present a major opportunity for impact. Active investors use several tools to influence change, including proactive proxy voting, dialogue with corporate executives, shareholder resolutions that are voted on at company annual meetings by all shareholders, investor letters and statements, and public policy advocacy. We amplify this impact by writing white papers and thought pieces to educate our clients, other investors, and the public on the issues on which we are focused.
In the public equity space, many also equate impact with investing in thematic, solutions-oriented companies. But I would argue that there is little additionality there. Impact doesn’t happen by accident — it must be intentionally driven by the investment firm and the firm’s mission. While ESG-related performance is an important indicator of a company’s management and its oversight of emerging issues, the uncomfortable reality is that companies rarely move quickly or pivot to address a societal or environmental concern without pressure. Productive and timely change is often inspired by investors who prod them to action. The impact here is in how we define the changes that we want to see and the ripple effect we want them to have. A policy change is only a piece of paper if it is not implemented and monitored.
The uncomfortable reality is that companies rarely move quickly or pivot to address a societal or environmental concern without pressure.
Having impact means getting companies to change their behavior and correspondingly seeing lasting outcomes related to those changes. Simply pushing for a policy change at a company, in my experience, usually results in very little actual impact on the ground. Firms looking at investments only from a risk analysis perspective may be satisfied when a company has checked the box on a policy. But it’s not enough just to check the box. Companies, with their massive influence, need to be asked: what is different in the company after a policy is adopted? How is it changing a behavior, a strategy, or a function to achieve a better goal? What impact is a company having when it employs, expands, produces, or pollutes?
For example, consider diversity, equity, and inclusion (DEI) and racial injustice. The investor community needs to recognize that it has contributed to and benefited from racist systems and the entrenchment of white supremacy. It seems instinctive to listen to and engage with BIPOC voices in investor spaces and company engagements. Committing to integrating racial justice into investment decision-making and using our investor voice to advance anti-racist public policy will drive impact. Checking the diversity boxes will not.
Simply pushing for a policy change at a company, in my experience, usually results in very little actual impact on the ground.
And with all my reverence to our collective work here, there is a failure of public equity managers to listen to and engage with NGOs, community groups, and other grassroots voices to understand the trickle-down effect of corporate or policy activities. Most of the world lives in emerging markets, and there is a very real risk that what some investors ask of companies could have significant, unintended consequences on the ground that reinforce inequitable power structures.
Carbon credits are another open area of concern. In the haste to clear up emissions from portfolios and operations, too many investors and companies alike are selling off carbon-intensive industries or buying credits to offset the carbon while keeping the status quo. So, portfolios grow greener but only because they invest in the less polluting industries, and companies continue to emit unabated when they pledge net zero emissions and buy the pollution off through questionable offsets. We might see as a result, trees being planted on the other side of the world that don’t live past being saplings (lack of permanence), or through protecting forests that were already under conservation agreements (lack of additionality), or communities displaced to build projects about which they were not consulted (leakage). Failing to undertake due diligence and to listen to and understand stakeholder concerns creates a huge blind spot for everyone, and risks having unintentional negative impacts.
Impact investing in public equities is nuanced and resource intensive but it’s the next step beyond ESG.
Impact investing in public equities is nuanced and resource intensive but it’s the next step beyond ESG. Now that ESG has tilted toward common sense, going further means setting intentions to pursue meaningful outcomes from companies to accelerate and amplify the transformation we seek.