Is Sustainable Investing Sustainable?

By Daniel Litvin (Founder and Senior Partner) and others (see below)

The Big Question is a regular feature in which Project Syndicate commentators concisely address a timely topic.

ESG investing: facing growing pains?

Tumbling equity markets and greater regulatory and public scrutiny are subjecting previously fast-growing green investments to what may be their toughest stress test yet. As fears of recession increase, many believe that an industry based on the promise of making money while doing good may be facing a reckoning.

In this Big Question, we ask Daniel Litvin, Bertrand Badré, Karen Karniol-Tambour and Eva Zabey to assess the future of environmental, social, and governance investing.

DANIEL LITVIN

While the sustainable investment movement continues to hold great promise, it urgently needs reform so that its potential benefits are not overwhelmed by a backlash. In a 2019 commentary, I noted the movement’s Achilles heel: that its proponents risked overselling its merits and inviting opposition. That is now clearly happening, with Elon Musk (among a growing band of critics) recently describing ESG investing as a “scam.”

The backlash has further to go. It unites those on the left, who naturally think capitalism cannot be much improved, with those on the right, who see ESG as an attempt to impose irritatingly “woke” leftish values on the financial world.

Amid these suspicions, the basic premise of sustainable investing remains sound. By behaving responsibly and helping to tackle societal problems, companies can often improve their bottom line, seize new opportunities, and manage risks more effectively. Moreover, for the biggest challenges the world faces, such as climate change, businesses obviously have significant influence over outcomes.

But the rapid recent growth of sustainable investing has been built partly on shaky foundations. Some financial institutions have been taken to task for overstating their ESG credentials. Many rely on metrics that can be flawed or based on insufficient research to measure companies’ sustainability performance, or “ESG ratings.”

ESG methodologies often embed highly subjective judgments about what constitutes good corporate behavior – a point rarely acknowledged. Those promoting ESG funds have also downplayed the risks that ESG investors will sometimes forgo returns in the short term (fossil-fuel stocks have soared this year, for example).

All of this is remediable, but not without a concerted reform effort. The sustainable investment movement needs to double down on the quality of ESG data, align around stronger standards, frankly acknowledge ESG’s limitations, and stop making exaggerated claims to be saving the world. Modesty and rigor should be the virtues of the day.

BERTRAND BADRÉ

There are different ways to read this provocative question.

One could first ask whether we are not disputing a pointless question: If an investment is not sustainable, then it probably does not qualify as an investment. End of story.

But if we connect the dots between this question and the “sustainability question,” as reflected in the Sustainable Development Goals, then things become a little trickier. Sustainable investing in opportunities, companies, and projects is emerging as an investment category. We have moved from a self-defined approach (I say an investment is sustainable because I know it is) to a loose ESG framework (I can find a framework that confirms my investment is sustainable). We must hope that the next stage is a rigorous methodology anchored in norms, rules, and recognized market practices – impact investment.

We are at a turning point that will determine whether we are capable of addressing this issue in a unified manner. Sustainable investing cannot survive as a separate category, where investors put some money in a particular basket in order to feel good. If this were the case, it would mean all other investments were “unsustainable,” which could not work for long.

We have to work to make sustainable investing the norm. If it remains merely a nice add-on or a beautiful cherry on a cake, this will disqualify finance as a tool to address today’s big global challenges.

So, let us take our toolbox, open the hood, and work on the engine. It is time to adjust our financial operating system and move from the traditional risk-return equilibrium to a “risk, return, and sustainability” approach. If we cannot take that step, we will have a much bigger collective problem and fail to meet our collective commitments to build a resilient, inclusive, and sustainable economy.

KAREN KARNIOL-TAMBOUR

Sustainable investing will remain a sustainable long-term trend. Investors globally are increasingly asking themselves: How does my invested capital affect the world? If the goal of investing is to leave money behind for generations to come, what kind of world will my investing leave to my heirs?

These questions are leading investors to incorporate sustainability (and, increasingly, social objectives) into their investment mandates. Most commonly, they pledge to align their investments with the net-zero transition, which is a long-term and binding commitment. For example, if investing in expanded coal or oil capacity proves profitable in the coming years (because there is an energy shortage, and because other investors are unwilling to fund such activities), net-zero investors commit not to take advantage of such opportunities. Instead, they will ensure that their money contributes to moving the economy to net-zero emissions.

These shifts will be consequential and long-lasting. Once sustainability is embedded in investment objectives, it will eventually percolate into funds’ governance structures, hiring decisions, incentive systems, investment training, risk-analysis frameworks, and, most importantly, asset allocation.

Reinforcing this are the numerous global regulatory regimes and industry bodies requiring investors to report on the impact profile of their portfolios. These include the forthcoming Sustainable Finance Disclosure Regulation in Europe, new proposals from the US Securities and Exchange Commission, Australia’s Modern Slavery Act, and emerging industry standards like the Task Force on Climate-Related Financial Disclosures. Over time, this investor focus will affect the behavior of corporations, which are under increasing pressure from investors and other stakeholders to improve the sustainability of their business models and practices.

EVA ZABEY

Not yet. But it will be.

Investing – including sustainable investing – does not occur in a silo. It relies on having the right regulatory and accountability systems in place. These are not yet mature enough for us to say with confidence that all “sustainable” investing is truly sustainable today.

But things are changing. Sustainable investing has matured from a basic assessment of a company’s activities (usually focused on managing risks and screening out bad investments) to valuing an investment’s actual effects and dependencies in tackling social inequality, the climate emergency, and nature loss. Demand for these purpose-driven investments is increasing, creating an opportunity to transform systems so that investing contributes to an equitable, net-zero, and nature-positive future.

What else needs to change?

We need reliable, consistent, and transparent financial information on the real impact of sustainability investments. While criticizing the experimental way such investing works today is relatively easy and often justified, it is not the time to give up altogether. Rather, we need to continue to highlight the demand for these products and encourage governments to set the rules of the game. For example, Business for Nature is calling on governments to adopt mandatory requirements for businesses to assess and disclose their activities’ impact on biodiversity. This will lead to better decisions for people, the planet, businesses, and investors themselves.

The sustainable investing industry is like a teenager surprised by a growth spurt and is now determining exactly who they want to be when they grow up. We need to make sure the industry matures well, and quickly. When it does, we won’t even need to qualify any investment as “sustainable” anymore, because by default all investments will be.

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Please see here for the original version of the article on the Project Syndicate website.

Daniel Litvin, Founder and Senior Partner of Critical Resource, which advises energy and resource companies on sustainability and geopolitical risk, is a visiting senior fellow at the London School of Economics’ Grantham Research Institute and the author of Empires of Profit: Commerce, Conquest, and Corporate Responsibility (Texere, 2003)

Bertrand Badré is a former managing director of the World Bank, is CEO and Founder of Blue like an Orange Sustainable Capital and the author of Can Finance Save the World? (Berrett-Koehler, 2018)

Karen Karniol-Tambour is Head of Investment Research at Bridgewater Associates

Eva Zabey is Executive Director of Business for Nature