Sustainable Investing – Greenwash or the Real Deal?
What if you could retire young by building schools in Africa, secure a future for your children by fighting racial injustice or finally exit the ‘rat race’ by saving the world? All of this and more can be achieved, according to its proponents, by sustainable investing.
Simply put, sustainable investing aims to financially promote a positive cause while preserving or growing the wealth of the investor. Major investment banks, private equity and hedge funds all market themselves as proponents of either socially responsible; environmental, social and governance (ESG); or impact investing. Socially responsible investing (SRI) accounted for $30.7 trillion of all assets globally in 2018, up from $13.3 trillion in 2012. As charitable as it sounds, it is essential to understand what these investments actually mean and if they have the power to save the world, or if they act as mere tools for ‘woke marketing’. Let us start with definitions.
There are three types of sustainable investments:
Environmental, social and governance
ESG creates guidelines and risk factors by which investors judge the potential impact of a given investment. The goal is to determine the material risk of the investment to generate maximum financial returns.
Since the Covid-19 pandemic, many ESG indexes such as the S&P 500 ESG have outperformed their parent indices. According to BlackRock, this has been caused mainly by businesses improving their supply chains and management practices which better prepared them for situations like the current pandemic. If the theory is right, ESG can genuinely be the answer to risks like climate change, as their socio-political effects will be similar.
Socially responsible investing
SRI selects investments based on specific guidelines which may be related to ESG. Screening of investments can be either negative or positive. Negative screening refers to researching a potential investment and not including it in the portfolio if it violates specific criteria (oil, gun, tobacco companies). Positive screening refers to choosing specific investments which promote an area of value (education, green energy, diversity).
The goal of SRI is to maximise profit while adhering to specific sustainable benchmarks.
Impact investing puts positive impact before profit maximisation. Funds may thus pick investments which will promote a specific area of value, but which may not generate market or even any returns. However, today’s impact funds are already capable of achieving both. Therefore, the distinction between SRI and impact investing does not lie in capability but intention.
Intention plays an essential role in impact investing, as all types of investments ultimately generate a positive effect. Investing in oil companies may prove detrimental to the environment. Still, it will foster employment and economic prosperity of the parties involved. An investment is ‘impactful’ when its specific impact is intended and when the overall good caused has a net positive value. It is almost impossible to calculate whether investing in an oil company will bring more good than harm by creating employment opportunities through destroying the planet. However, it is much easier to decide so in the case of an educational start-up. The world of finance is inherently utilitarian, and if one wants to do good, one must use the same approach in impact investing.
Although the term ‘impact investing’ was coined in 2007 by the Rockefeller Foundation, its history stretches far back to the ancient era. Early Judaic, Muslim and Christian religions all advocated for socially responsible investing, but it was not until the mid-20th century when global institutions acknowledged their social responsibility in the area of finance. As impact investing is still young, many investors have a sense of a false dichotomy, that is that their investments will either generate positive impact but concessionary returns or vice versa. The reality is that impact investing aims to create a ‘blended’ world which will combine both into a supreme form of investment. One example would be improving employee diversity to boost returns of the company.
However, not all is roses. Sustainable investing is still defined by each company, investment fund and credit rating agency which gives them leverage to use it for greenwashing. Elad Roisman, a senior commissioner at the Securities Exchange Commission, called for stricter rules in disclosing business information to decide their ESG value. Because companies disclose their business data themselves, they sometimes do not know whether some of their practices are wrong and thus do not disclose them. However, if companies receive investments based on their ESG ratings, it is logical that they would only disclose positive information.
One of the recent controversies in the area of sustainable investing was the case of the UK-based fashion company Boohoo. After being accused of poor working conditions and sub-standard labour rights, it has been found out that Boohoo received a double A-rating (the second-highest) in the MSCI ESG Ratings. Ketan Patel, a fund manager at EdenTree Investment Management, said that ESG managers should be doing their own research on the sustainability of investments. However, this would destroy the need for ESG credit rating agencies in the first place. If these agencies are to have their place in global markets, they should have tight regulations on ESG data disclosure. Otherwise, people will be misled into investing in companies like Boohoo while feeling ethically well about themselves.
In sum, sustainable investing may be the future of global markets. But unless governments create transparent, fair and tight requirements on the definitions of ‘sustainability’, that future may remain but a dream.
By Jonas Nepozitek, VP at the King's Banking and Finance Society
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