When I started to talk with asset owners and managers about ESG investment (liquid side of sustainable investment) and Impact investment (illiquid side of sustainable investment), everyone asked me “Robert, that is fascinating but could you please send me research proving that at worst ESG didn’t underperform the market and that at best it outperformed”. I would respond by sending the research that was at hand and this went on for years. Then, I had the “aha” moment and realized that this was not about proof, but it was about belief. I looked at how much research was done on CDO (collateral debt obligations) as a risk. I couldn’t find any, but I am sure it existed. Then, I looked at how many people who did find any research actually read it. Nearly no one. Finally, how much money went into CDO’s? Too much. Those investors believed without proof that CDO’s linked to mortgages would churn out returns forever, without any proof.
I stopped sending the research about ESG.
The really big drivers of ESG and Impact investing are at the macro level of resource depletion, being driven by emerging market economic growth. For example, Lester Brown, of Earth Policy Institute, highlighted in Plan B the stresses that would come from China’s growth. At 8% growth, China would reach US consumption levels, in 2030. This would translate into an oil consumption rate of 99 million barrels per day (present consumption is about 84 million worldwide). This massive commodity requirement is even worse if we look at grain, iron ore, paper, coal, steel, and meat. If we then add India to the mix, and then the other 3 billion in emerging markets and the developed world, one can see that linear growth is not possible at this level of inefficient use of resources or with present business models. We won’t have enough. “The Western economic model — the fossil fuel based, automobile-centered, throwaway economy — will not work for China,” Brown said. So, the only way to continue the growth is perhaps conflict for resources, which is not a good long term option. The real opportunity for the financial sector is a massive drive for resource effectiveness or efficiency, which is what sustainability is about. Doing more with less. This also translates into more profitability.
The money flows in both ESG and Impact has been significant. In the ESG (liquid) space the US Social Investment Forum reported that the ESG Market had reached $ 3.74 trillion in 2012 and the European Social Investment Forum reported a market of € 6.76 trillion in 2012 (which includes stocks and fixed income). In Impact Investing (illiquid) the Green Transition Scoreboard, which tracks investments in various sectors working on a greener economy ((cleantech, smartgrid, energy efficiency, green constructions), reported a significant jump in investments to $ 5.2 trillion between 2007-2013.
Many like to consider ESG or Impact as a niche. I like to look at it as a big party and we got there early. Considering all the institutional barriers which prevent ESG and Impact Investing from growing, and they have continued to grow consistently, the only conclusion is that they are a natural force, seeking their own way irrespective of obstacles, and will continue to grow. What are the barriers to institutionalization of ESG and Impact?:
- The Financial sector (asset owners and managers) know what they already know and it is challenging to get new thoughts through.
- Media gives little attention to the issue of sustainability. The information that is provided over and over, what did the Dow do today is not an effective instrument for institutional invest.
- Few incentives exist for analysts or fund managers to truly embrace ESG and Impact, from the organizations where they work.
- Trustees hide behind the words “fiduciary responsibility”, when the Freshfields Report I & II clearly said that fiduciaries that don’t take extra financial (climate change) issues into account are perhaps not fulfilling their fiduciary responsibility and that there is no legal restriction in developed countries for not embracing sustainability issues.
- On the policy level, products don’t reflect their true cost. If you buy a bicycle in Europe there will be nearly 21 % in sales tax. If you buy an airplane ticket there is no sales tax or taxes on kerosine.
- Many wealth advisors and gate keepers have not been educating their clients about ESG and Impact Investing
- The vast majority of MBA schools have been teaching traditional courses and few were offering a fully integrated teaching program on Sustainable Finance. It is slowly changing.
- A key challenge is management isolation. There is always a barrier to new information getting through, and the network of management also thinks along the same lines. Getting new information is very hard.
- Most important, the financial sector was not convinced (belief), but that is changing, slowly.
How do we get from proof to belief? No magic bullet. It is just continuous chipping away at the walls of isolation, improving awareness, no ribbon cutting, but plenty of digging ditches. Most important, you need to show self interest (what’s in it for me?), opportunity (where can one invest?) and money flows (where is the money going?). It is not brain surgery, believe me.
About the author:
For the past twenty years, Robert Rubinstein, has been instrumental in integrating ESG and Impact Investing into the culture and strategy of international corporate business and investment companies.