The case for a multi-pronged approach to impact
Headlines about the rise of sustainable investing have been seemingly all over the place in recent years. Between 2018 and 2020 alone, total US assets applying environmental, social and governance (ESG) criteria increased by 42%. Bloomberg analysts to predict that global ESG assets will exceed $50 trillion by 2025.
Amid this surge in activity, one question lingers: is this reallocated capital really making a difference? As industry onlookers (rightly) decry the cynicism greenwashingand so serious projections about the scale of the climate crisis, there is an ongoing debate about the optimal and most effective approach for environmentally and socially conscious investors. Let’s dive into three of those most commonly used by Ethics clients to respond to ESG issues:
One approach, often referred to as impact investing, is to actively seek out companies whose mission and business activities are perceived to benefit the environment, society, or both. An investor wanting to accelerate the adoption of “green” technologies could build a portfolio that intentionally directs capital to pioneering companies in renewable energy, electric vehicles, sustainable agriculture or recycling solutions.
Of course, it’s important that investors have visibility into the methodology and data used to assess a company’s sustainability credentials. Otherwise, they run the risk of unwittingly pumping money into a company that only takes cosmetic steps to appear more sustainable, or has positive impacts in one area but a poor track record elsewhere. For example, an investor might be dismayed to discover that they have allocated capital to companies that are leading the way in reducing carbon emissions, only to find those same companies involved in gross human rights abuses.
Much of the sustainable investing conversation to date has focused on divestment, also known as negative selection. This process involves the use of a specific set of criteria, usually informed by the investor’s own values and preferences, to determine which companies, sectors or business activities should be excluded from a portfolio. Some investors might choose to avoid entire sectors, while others might exclude a handful of stocks that have a poor track record on certain issues relative to their peers.
Evidence suggests that this exercise is more than just a feel-good business and can, in fact, protect investors from undue risk. Like various real world examples have illustrated, the failure of companies to adequately manage environmental, social and governance concerns can expose them to reputational, regulatory and physical issues that can have significant financial consequences.
The divestment move is actually aimed at putting downward pressure on stocks, making it harder (and therefore more expensive) for some companies to raise new capital. Activists have long called for big institutions to shed fossil fuel investments and their efforts could pay off, as research indicated that oil companies are finding it increasingly difficult to obtain financing. In addition, high-profile divestment campaigns can have a snowball effect: where an influential institution works, others can follow.
Divestment has certainly served as an important advocacy tool, stimulating important conversations about the role of investors and the broader financial services industry in promoting more sustainable outcomes. However, despite its ability to capture widespread attention, divestment is only one potential way to effect real change. Recognizing this reality, some values-aligned investors are choosing not to walk away from all bad corporate actors, but in many cases to stay firmly in the fight.
As mentioned above, some ESG investors are reconsidering divestment and instead consciously choose to hold their shares in “problem” companies. Although it may seem counter-intuitive to some, there are increasingly school of thought that active shareholder engagement is essential to achieving positive social and environmental outcomes. Support for this approach, especially when it comes to catalyzing climate action, is growing following high-profile statements shareholder campaigns performed in 2021.
The main idea behind shareholder engagement is that as a partial owner of a company, an investor has a say in how it conducts its affairs. This usually takes the form of voting on shareholder proposals (or resolutions) that cause the company’s management to take a specific action or disclose certain information. These proposals are put to a vote at the company’s annual general meeting, with most investors choosing not to attend in person, but instead filling out a proxy ballot that authorizes another party to vote on their behalf. .
Proponents of shareholder engagement might argue that the divestment movement does little to address the underlying economic problems of “dirty” industries such as big oil. In other words, for every fossil fuel stock abandoned by an investor, there is more than likely a less climate-conscious investor willing to hang on for a favorable price. In effect, this means that the environmentally conscious vendor has given up their place at the table and can no longer use it to incentivize companies to adopt more responsible behaviors. And it is indeed encouraging evidence that shareholder engagement can lead to more positive corporate actions, in part because companies respond to targeted, specific demands rather than broad societal pressure.
Institutional investors, who own most of the shares of companies and therefore wield outsized influence, are more active in proxy voting than individual investors. But these institutional investors often manage assets on behalf of retail investors and come under increasing pressure to align voting activity with their public engagements on burning issues such as climate change. Indeed, in 2021, investors demonstrated record support for environmental and social shareholder proposals, demanding more transparency on political donations and corporate lobbying, diversity and inclusion initiatives, and efforts to address greenhouse gas emissions.
Where do we go from here?
There’s also a lot to be said for the role of regulatory oversight when it comes to tackling such big and far-reaching issues as climate change. However, in the absence of substantial government intervention, it is up to investors to weigh the merits of the choices available to them: direct more capital to impact leaders, ditch bad actors altogether, and/or use their voice as shareholders to influence key issues.
Given the lack of compelling evidence that a singular method represents a panacea, we see impact-minded individuals taking a multi-pronged, “carrot and stick” approach to sustainable investing. Simply investing in ‘good’ companies can be tricky, because even if a company may be ‘doing well’ on carbon emissions, for example, it may come up against other questionable practices. Merely divesting from “bad” companies ignores the potential improvements an industry can make and silences an investor’s ability to speak their mind. One thing is clear, however: sustainability investors of all stripes are pushing companies to assess their impacts on people and the planet.
We are at a critical juncture in our fight against pressing issues such as climate change, and the gravity of the moment demands that we use all the tools at our disposal. While the jury has chosen the most effective approach, what we do know is that we cannot sit back and do nothing.
Alex Laipple is Head of Business Development and Emma Smith is Director of Communications, at Ethics. Ethic is an independent provider of custom direct indexing solutions. Its scalable platform enables financial advisors to deliver passive equity portfolios that meet growing investor demand for personalized, values-aligned solutions.