Or do they? As much of a staying power as Milton Friedman’s credo has had in the modern world economy, it might be time to rethink things.
At least, that was the message coming out of the latest Business Roundtable a couple of months ago, where US business leaders came out with a timely message for sustainability.
Some choice quotes from key people included JP Morgan boss (and Business Roundtable Chairman), who said “The American dream is alive, but fraying… Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term.”
Tricia Griffith, President and CEO of Progressive Corporation, added that “CEOs work to generate profits and return value to shareholders, but the best-run companies do more. They put the customer first and invest in their employees and communities. In the end, it’s the most promising way to build long-term value.”
Now, if we’re feeling cynical, we could say this is just paying lip service to current buzzwords like sustainability and environmental, social, and governance-focused investing. You might know that last part as ESG.
And it’s true that this has been an issue for ethically-minded investors. It’s all well and good to have a clear conscience and invest in good causes but, at the end of the day, investments need to generate returns. If ESG-focused investments aren’t paying off, should investors keep pursuing them just for the sake of ethics?
Similarly, if businesses generate profits despite sticking with shady practices, anti-environmental policies, and no regard for the social impact of their practices, is there a practical reason for them to lean into ESG? In fact, aren’t they in breach of their fiduciary duties to shareholders if they do and profits plummet as a result?
The Business Roundtable’s announcement is important, even if it’s just grandstanding, because it seems to be willing to break that particular taboo. The message is clear: shareholder interest should not be the only Northern Star a business follows. It’s good, then, that there is data that seems to reward this mindset.
According to Allianz’s ESG Investor Sentiment study, published last year, two-thirds of millennials stated that ESG considerations were important to their investment decision-making. More than half of their Generation X counterparts said the same, whereas only 42 percent of Baby Boomers agreed.
It’s clear that for the new crop of investors and shareholders, sustainability is a concern – and this means that businesses also take notice.
It certainly seems to be in their best interests to do so: Investments with a sustainability mandate were more than US$30 trillion in 2018, a 34 percent increase from the two years before, as per a report from the Global Sustainable Investment Alliance.
ESG Research Comes of Age
Where does that leave research? ESG-focused research has been the subject of much eye-rolling, as the buy-side seeks to separate the objective, substantive wheat from the marketing and ideologically-driven chaff.
“A major source of frustration for investors is that out of the vast corpus purporting to be ESG alpha research, only a fraction: 1) is actually about alpha even when it thinks it is, and 2) can pass for real research based on objective, analytically-rigorous methods,” writes Kyle Rudden, an independent analyst focusing on “alpha-centric” ESG research.
Rudden, who recently started publishing on Smartkarma, is confident that ESG research can be objective, generate sound investment ideas, and put data ahead of ideology. He should know – Rudden cut his teeth working on the sell-side for JP Morgan, where he managed the Global Energy Research Team.
There, he encountered a spate of ESG failures in the market, from governance failures like the Enron scandal to environmental and social debacles that evaporated billions of dollars in shareholder value.
Read Kyle Rudden’s full Insight: ESG Alpha: Fluff or Stuff?
“All this time, I was doing ESG research without knowing that’s what I was doing,” he recalls. “When ESG entered the zeitgeist, it provided a framework that cast earlier experiences in a brighter light.”
This taught him the importance of ESG research based on hard facts and data, without the ideological baggage and other biases that can sometimes come with this line of thought. These can skew research, especially when it promises alpha – the industry shorthand for when an investment idea has managed to beat the market return for a certain period.
That’s what makes Rudden’s approach to ESG research alpha-centric: deriving alpha from ESG, focusing on the causal relationships between the two, rather than alpha with ESG, which just seeks to generate alpha while also adhering to ESG principles.
Of course, there’s a reason why this isn’t more common in the industry. Not only is it a lot of work, there are unique challenges inherent to ESG. Limited data, inconsistent reporting cycles, and expensive integration make things harder.
Some of these factors have been highlighted elsewhere, such as BNP Paribas’s ESG Global Survey earlier this year.
Ultimately, demand – itself a powerful market force – will determine the future of sustainable practices in business, investment, and research.
Speaking on the sidelines of Institutional Investor’s inaugural ESG Investing Summit in New York, T. Rowe Price’s Director of Research for Responsible Investing, Maria Elena Drew, said that companies the asset management firm invests in have started disclosing more information on ESG issues, because more of its clients ask for it – which then sheds more light into those companies’ practices.
“As companies disclose more data, it makes it a lot easier for us to analyse how they operate from an environmental or social or ethical perspective,” she noted.
Lead image by Singkham