The Truth About ESG And Improving Returns

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by Eric Burdon,

BlackRock, Inc.

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Even though ESG is a no-brainer for businesses, the world of finance is more nuanced. It is to the point that Alex Edmans, a finance professor at London Business School, can confidently say you can either make an impact or improve returns, but not both.

He stressed this point in an episode of the ESG Out Loud podcast, where basic finance theory suggests you can only have one or the other. And yet investors, finance professors, and policymakers still make the claim that you can do both.

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Edmans used the analogy of buying organic food at a grocery store. We all know as consumers that organic food generally costs more than regular food. The key difference is there is more labour and, therefore, more cost involved in organic farming, developing the raw materials, than there is with regular crops. Another great example is plant-based protein. Economically, plant-based protein is in smaller packaging than regular meat. Furthermore, the price for either one is about the same.

The reason those foods are popular isn’t because people who buy them are saving money. Rather, they’re choosing to buy these goods because there are additional benefits and these foods can have a better impact on their lives.

Investing in ESG works in the same manner, where investing in ESG is more for the benefit of society and the planet and not necessarily because an investor is going to make immediately improved returns in the short-term than if they didn’t invest in ESG. The Bain and EcoVadis joint study clarifies this. The difference is the benefits will compound over the mid- to longer-term, since ESG involves making decisions to develop operations that increase the effectiveness of resource use, and to improve efficiency means to reduce bottom line costs and increase profitability.

With this in mind, it’s important to be wary of funds in the corporate world that claim they can give investors improving revenue returns year after year on top of making a positive impact on society. That claim, as Edmans argues, is a false promise to new investors.

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ESG Is Also About Honesty

When it comes to investing and ESG, the biggest action to take is to be honest. As much as we like to think ESG is a significantly better investing strategy than standard strategies while delivering a positive impact, the reality is that it’s mostly the latter.

The key is to be honest about it and find other ways to show those improvements. As with the study mentioned above, in recent years there were improvements in private companies that adopted ESG activities. Slight improvements are still important, since they compound, but ESG investment strategies don’t 'blow out' traditional investing and finance strategies.

And that’s okay.

Just like with organic food, the purpose is to support the farmers who are putting in the extra effort to provide these foods. It’s to support companies offering healthier alternatives than the ones we’re so used to. It’s about impact rather than thinking with your wallet, about developing ideas of what constitutes value outside of mere growth and shareholder returns. 

Edmans provided another example in the form of climate proposals from companies. Fiduciaries have a tougher time voting in those because voting in them could violate fiduciary duties. Fiduciaries are to act in the client’s best interests, but they also can’t directly influence long-term returns in the same way non-fiduciaries can.

To vote for a climate proposal that could improve the returns of a company would violate their duties.

And so it’s important to get clear and be honest with the messaging. For new investors, it’s crucial to have that, or else they will believe in those false promises.

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ESG Is About Clarity 

Specifically, clarity on the terminology For new people learning about ESG for the first time, there is no unified definition of what ESG is. ESG investing is in the same boat as well.

On one hand, ESG investing is simply an investment philosophy. It’s not about saving the world but rather creating long-term financial returns as you would with any form of investing. On the other hand, there are people like Larry Fink, CEO of BlackRock Investing, who associate climate risk with investment risk. His view is that it’s another iteration of capitalism where it creates financial value.

That belief is why BlackRock is experiencing hiccups as of late.

On the other side, there are those who are like those who buy organic food. They believe ESG is about creating social value and changing the world. These are the investors who encourage companies to decarbonise, change up the diversity of their workforce via insightful hiring practices, and improve social and environmental impact in communities, even if this doesn’t equate to better financial returns.

Which companies are performing with their ESG responsibilities? Bookmark our Company ESG Profiles listing to keep track of ESG ratings and updated published reports.

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