Andrew Ross Sorkin’s article in the New York Times, Can Good Corporate Citizenship Be Measured, made for excellent reading and a hearty meal for thought. For instance, he points out that while the term “ESG” (which stands for environmental, social and governance criteria) is commonly heard in boardrooms, many on Wall Street have “privately cast a skeptical eye, chalking up all the bluster on the topic to politically correct marketing efforts run amok.”
That they have, those nameless “many on Wall Street.” But as Sorkin notes in the article, that is changing as more solid evidence is produced on the performance of sustainable investing, such as a recent study from Bank of America noting that “ESG is the best signal we have found for future risk” and “stocks that ranked within the top third by E.S.G. scores relative to their peers would have outperformed stocks in the bottom third by about 18 percentage points from 2005 to today.”
That Bank of America study is only one piece in a wealth of literature, from both academia and financial institutions, that supports the idea that when sustainability is used in investment, returns do not suffer, and often outperform traditional investment (a term we often use to describe investment that does not intentionally integrate ESG factors). A quick smattering of findings from recent studies examining the investment usefulness of ESG:
That, as I mentioned above, is only a smattering—there are hundreds of studies that make similar points regarding the links between sustainability and fund or company financial performance.
So why would Wall Street (and others—this isn’t just a U.S. thing) find so many ways to ignore or dismiss such evidence as “politically correct marketing efforts run amok”? I suspect that at least part of the reason is just human nature, something that is illuminated by the Nobel Prize-winning research done by Danny Kahneman and Amos Tversky, who changed the way we think about thinking. Dr. Kahneman’s speech on winning the Nobel Prize expressed this well by saying “We were also impressed by the fact that significant research decisions…are routinely guided by the flawed intuitions of people who know better.” This happens in all fields, as Michael Lewis chronicled in his book about Kahneman and Tversky. He illustrates the point by noting that “The core idea of evidence-based medicine was to test the intuition of medical experts—to check the thinking of doctors against hard data. When subjected to scientific investigation, some of what passed for medical wisdom turned out to be shockingly wrong-headed.”
Finance, like everything except possibly horseshoe crabs, changes in real time. What made for good investment practice decades ago—or even a decade ago—may not be the platinum standard today. The fact that sustainability is important to corporate financial performance is an idea that’s been growing in importance and acceptance for decades—slowly at first, but much more rapidly in the past decade. In fact, a Pensions & Investments editorial recently stated, “The discussion of the merits of including social and governance factors in investment decisions seems to be over.” Not everyone in finance is going to like that, because integrating sustainability into financial management isn’t something that can be done using an off-the-shelf spreadsheet of ratings. It requires knowledge and judgment to really examine sustainability of investment possibilities, and a lot of people who are already experts in finance don’t want to hear that continuing to be an expert will require mastery of new disciplines.
That’s probably why you hear so many complaints that sustainability ratings are “fluffy” or “soft” because they don’t always agree. News flash: that’s also the case in traditional finance. It’s not uncommon for different financial analysts to rank the same company many ways—from sell to buy—at the same moment. Yet that seems not to perturb anybody, or to be a problem that finance must deal with in order to incorporate financial data. The idea that different experts rank the same company different ways is neither a show-stopper for ESG integration into financial management, nor is it something the market can’t handle. We just need to get over the idea that sustainability is somehow different from the financial factors that analysts routinely examine, every day, and factor into investment decisions.