Does responsible investing make the world a better place?

 By Mike Ross

I once met with a fund manager who told me his business had started offering responsible investment funds for clients who wanted to feel ‘warm and fuzzy’ about their investments. The comment irked me. At the time, I was offering ethical investment options that I believed were achieving much more than a feel-good factor.

But by making this statement the fund manager did raise an important question - one we should all be asking ourselves: Does responsible investing make a difference to the world we live in?

Responsible investing (also referred to as ethical investing), has seen exponential growth over the past few years as a result of investor demand. But lately the industry and its practices have been under intense scrutiny, including well-founded accusations of greenwashing and a lack of regulation.

An editorial by associate professor Hans Taparia in the New York Times called responsible investing a “sham” that falsely leads investors to believe their portfolios are doing good for the world. The Economist recently printed that the ethical investment industry had become a source of “eye-rolling cynicism”, made up of subjective measurements and disparate goals which it fails to achieve.  And Tariq Fancy, Former Head of Sustainability at Blackrock (the world’s largest investment manager), claims responsible investing is a dangerous distraction from what really needs to change to tackle environmental and social issues: regulation.

The crux of this commentary is that at best, current responsible investment practices make little difference to the world at large, and at worst, are a major distraction from regulation which could make a real difference. Some of this criticism is valid. But amid the noise, speculation and commentary it’s important to focus on the facts, data and analytics we have to hand. That’s the information we know to be true. And it tells us three things:

1. Responsible investing can and does make a difference.
2. Shareholder value and stakeholder value are not mutually exclusive.
3. Industry practices need to improve to be impactful.

Responsible investing can make a difference

At a basic economic level, companies want to attract investors. It helps them raise capital to grow or increase their share price (to the benefit of management and the board whose remuneration is linked to share price performance). We’ve seen this in New Zealand’s electricity market. To attract more investors companies have made strong commitments to decarbonising their generation assets. For example, Contact Energy has committed to a major new geothermal power station to displace fossil fuel generation. And all over the world companies are adding climate change, pollution, human rights, and diversity to their business priorities in response to investor expectations.

Excluding companies has limited effect

A popular method of investing responsibly is to avoid investment in harmful industries or companies eg. tobacco and controversial weapons. The theory behind this strategy is to effectively lower the share price and make growth difficult. But global data shows that this practice doesn’t change the behaviors or performance of these companies. The reality is, if you don’t buy these shares someone else will, and not being a shareholder means you don’t have the ability to vote on the direction of the business. That’s not to say that exclusion shouldn’t be a part of your personal investment strategy, it’s just not going to make a tangible difference to the company or industry’s standards.

Investing in the best will affect change

A more effective strategy than exclusion is to invest in companies that are at the forefront of their industries and leading the way towards a sustainable future. These companies are reducing their carbon emissions, using their resources effectively and creating environments for their employees to thrive. By investing in these companies you are voting for a more sustainable future and showing the market that ethical practices are highly valued by shareholders and consumers. Of course, there is the risk of being greenwashed when doing your reading on companies’ sustainability practices. To avoid the pitfalls, read our feature on greenwashing and decide what values and principles are important to you and your investment portfolio.

Shareholder value and stakeholder value are not mutually exclusive

Investing in companies that are acting ethically doesn’t have to mean sacrificing financial gain. There are thousands of companies around the world proving that doing right by people and the planet aligns directly with doing right by the shareholder. We expect that companies who are embracing sustainable and responsible practices now will hold their value in the long run.

Always do your research

Investors need to do their research to understand a fund’s responsible investment strategy and the responsible investment outcomes that the fund is seeking to achieve. Responsible investment strategies can be broken down into two broad categories:

• Manage risk and maximise returns: if you account for environmental, social and governance factors, particularly their risks and opportunities, you can make better investment decisions, maximise returns, and minimise risk.
• Seeks a financial return alongside environmental and social good: invest in a way that leads to positive change while still earning a financial return.

These two categories can have cross-over but are not the same thing. A fund might incorporate ESG risks into its investment process and therefore claim to be a responsible investment fund. For example a portfolio manager could consider climate change risk but still invest in an oil & gas business because they thought it was cheap and therefore a good investment. This isn’t greenwashing per se but certainly won’t influence better outcomes, and may not align with what you thought you signed up for with a responsible investment fund.

In the local market we have seen significant improvement from some fund managers in recent years reporting their responsible investment strategies and outcomes. Both Pathfinder and Harbour Asset Management have published sustainability reports, and in the case of Harbour an impact report in relation to their Sustainable Impact Fund. These reports detail how they are actively working towards positive change and provide transparency into their responsible investment process.

Engagement = the greatest impact

Using your money to vote for a more sustainable future has another benefit: Shareholders can use their voice to affect change on the issues they care about and the governance of the organisation.

For example, Engine No. 1, an activist investment firm, was able to install three directors on Exxon Mobil’s board and pressure the company into reducing its carbon footprint and considering the risk of climate impacts on long-term shareholder value. It achieved this with the support of Exxon’s large institutional shareholders, BlackRock, State Street and Vanguard, asset managers who support the goal of net zero by 2050.

For those investing in funds (our preferred investment approach) this strategy is even more impactful as they have more shares and thus more power (as a collective). Funds can engage with companies on best practice and divest when there isn’t a serious commitment to sustainability. To see this form of activism in practice have a look at Harbour Asset Management’s sustainability report.

Industry practices need to improve to be impactful

Better disclosures are needed

Critics of the responsible investment industry do make a good point: The names, definitions and objectives used in the industry are a mess! There’s no agreed meaning of the terms ethical, impact, responsible or sustainable, to name a few. A crackdown on greenwashing by regulators will help improve this situation. But this will only go so far.

Complementing, not substituting regulation

We partly agree with Tariq Fancy’s main criticism of responsible investing, that it is “a distraction from what really needs to change, regulation”. Regulation, specifically in relation to our biggest threats, like climate change, is required, there’s no disputing that point. But that doesn’t mean responsible investing can’t complement regulation - rather than be a distraction from it.

But fundamentally, investors hold the balance of power in this discussion. They are the ones who can change outcomes - through public voting on candidates committed to climate change solutions (which can directly impact regulation), consumption choices and investment decisions.

Long-term value for both stakeholders and shareholders will come from the mitigation of climate change and increased investment in environmental and social progress. Regulators, consumers and investors alike are all playing a long game. But it’s one we all need to get on board with now to preserve the future of the planet, people and our own personal investments. Every individual investor is an integral part of this solution - and its ultimate success.