Every fifty years, a new way for investors to make money emerges. Will ESG data deliver knowledge that leads to positive action?
The first phase of the responsible investment movement has matured. We find our approach of arguing that scrutiny of the way companies respect their relationships with people, and the planet adds value to the investment decision-making process. Our stakeholders include the natural ecology, workforces, suppliers, customers, investors, taxpayers, and communities, both locally and in the global sense. We have demonstrated value, and so regulators, large investors, investment banks, and partner nonprofits mobilized to begin the process of standardizing data and providing it to investment decision-makers.
Roughly every fifty years a new awareness of a better way for investors to make money emerges. In 1934 Benjamin Graham published Security Analysis which forever shaped the way professionals approached the investment decision-making process. He argued that being disciplined, investing in the company—not simply the stock—and staying invested for the long haul allowed one to achieve superior results. His stock-by-stock approach prevailed for roughly fifty years before the next tidal wave of insight appeared: The Modern Portfolio Theory, which argued that thoughtful diversification would reduce risk and enhance return revolutionized portfolio management. Although Harry Markowitz introduced the concept in 1952, it did not sweep institutional investing until David F. Swensen famously built the highly successful Yale endowment by utilizing the theory in the late 1980s. Today we witness a global rush to investing with values, frequently referred to as Environmental, Social, and Governance, or ESG investing, although impact or sustainability investing is favored by many.
Modern Portfolio Theory did not remove security analysis—it is used alongside it. ESG will not cause the demise of security analysis and will not cause the demise of diversifying portfolios. Instead, it sets out to strengthen investors’ capacity to make sound investment decisions that help outcomes for their clients. Many on Wall Street did not expect this outcome, but as the idea spread, these people have become converts. In fact, we are now headed to universal acceptance that there is value added.
Carbon Disclosure Project is an example of what can be accomplished without specific regulation when investors voice an interest in a disclosure.
Thirty years ago, socially responsible investing, as it was called, was generally ignored by professional investors as a tool for making investment decisions. When it was discussed, concerns were raised. Was it possible to perform with such constraints? Was it legal? Who decides what is good and how do they weigh its pros and cons? Today we have set aside most of these concerns. There is plenty of academic literature and lived experience to give comfort to those who are hesitant.
I anticipate that the next several years will see an increase in standardized reporting on topics of interest to responsible investors. Many of these data points will result from demands by regulators. We have already seen the Securities and Exchange Commission mandate disclosures relating to executive compensation and board makeup. Some data points will continue to be collected voluntarily. Carbon Disclosure Project is an example of what can be accomplished without specific regulation when investors voice an interest in a disclosure.
What is good investing?
The question of who decides what is good is quickly emerging as a hot topic. Recent news that S&P Global does not consider controversial behavior that happened more than ten years ago drew some criticism. But I thought ten years was more than adequate and as I generally consider four years as adequate for the aging off of a concern. A difference of opinion is a good thing. All investors have identical information of earnings per share and the price of a security, yet some are buyers, and some are sellers. It is, as they say, what makes a market.
Nonetheless, for the sake of a strong outcome, advocates of the integration of social and ecological considerations into the investment process could benefit from a greater convergence over “what matters,” even if we do not agree on how to interpret it.
The Domini 400 Social Index
In 1989 Peter Kinder, Steven Lydenberg, and I created the metrics to identify a company’s impacts on several stakeholders in an even-handed way. With this tool, we could create a splatter of data points. We did not assign values to each data point, arguing that the investor should stand back from the canvas, stare, and see the points form a picture. Certainly, we had to decide which companies to put into the Domini 400 Social Index*, but there was no simple numerical entry point.
Currently, the largest research vendors have a tendency to use data points to come up with a single score for a company. It is an approach that is, in my opinion, unlikely to continue to be much sought after. As a portfolio manager, I am somewhat interested in buy-and-sell recommendations, but I certainly don’t take someone else’s opinion blindly. I want to know why and I want to know in detail about the tidbits of information that have helped me in the past, such as qualifications of top management or cash flow trends. The same is true for stakeholder analysis. I want to judge whether the company has taken steps to address its ecological damage or to attract and retain a diverse and empowered workforce. I have my prejudices as to what matters with what companies.
One of these prejudices is that the treatment of the taxpayer deserves greater scrutiny. If your employment base must rely on public assistance to make ends meet, your company is not, in fact, a functioning capitalist company. It is living on handouts and needs to be priced as such. I raise this only as an example of potential areas to explore for a greater understanding of whether a corporation is in fact a good place to invest money.
I believe there will be universal acceptance of ESG as a valid and useful tool for investment advisors; a move towards greater disclosure of granular data; a move away from top line scores; and an avalanche of new research on the approach.
In addition to how we, who manage impact portfolios, look at companies, a shift has occurred in how investors look at us. The issuer of investment products labeled as responsible or green is being asked to demonstrate consistency. If a mutual fund is green, the fund management is expected to vote green on proxies. This may seem simple and obvious to insiders in the field, but it was in reality not the case and has led to claims of greenwashing, confusing the public. Nonetheless, it is effectively moving mountains. Large asset managers are integrating value across proxy voting, headquarters building, diversity programs, and a host of other areas. Consistency will grow.
Intentionality is also under scrutiny. When Morningstar began to rate mutual funds for ESG, shock waves were set off as dozens of funds with a special purpose and no intentionality to be ESG were given good scores. Was a fund that bought only solar panel manufacturers really a “better” ESG investment than a diversified portfolio that intentionally engaged with its portfolio companies and had a prospectus stating that it used environmental standards to make investment decisions?
Top line scores are out. Granular disclosure is in
What do the next thirty years hold? I believe there will be universal acceptance of ESG as a valid and useful tool for investment advisors; a move towards greater disclosure of granular data; a move away from top line scores; and an avalanche of new research on the approach. This is not, however, as important as what the byproduct of our growth will bring. With data comes knowledge and with knowledge comes corrective action. That will be our legacy.
We are on the cusp of seeing our goals met. Our simple concept, the way you invest matters, will have positive real-world results.
This article originally appeared on GreenMoney, a publication covering sustainable business and impact investing since 1992, as part of our strategic partnership.
Featured image: Domini
