by Georg Kell & Andreas Rasche, published in Barron’s Economy & Policy
Sustainable Investing Book Cover
Sustainability and environmental, social, and governance investing used to be the buzzwords of activists. Today, c-suite executives and boards of corporations and financial firms are struggling to come to grips with these terms and the issues around ESG. Firms have an inkling that change in the investment world is afoot, but many have not yet realized that the forces driving ESG will soon force fundamental changes to their business.
We recently gathered the voices of experienced industry leaders as well as high-level academics in a new book that reflects on the current state and future direction of sustainable investing. The book tells the story of why sustainability has become a leadership challenge for corporations and investment firms alike by shining a light on the forces that have shaped the debate for years, and highlights an emerging consensus among practitioners and academics on what will shape the future of sustainable investing. There are three key lessons to take away.
First, there is a shared understanding that framework conditions for market success have been changing at an accelerating pace. A confluence of technological change, increased regulation, a growing need to respond to and anticipate environmental impacts, and related social and governance change calls for a fundamental rethinking of assumptions underpinning the way markets are functioning.
For corporate executives, the implication is that there is need to repurpose the firm based on a holistic understanding of these changing conditions. Such repurposing necessitates a move from incremental to more ambitious management where societal impact and low carbon processes take center stage. At the core of this move is the recognition that externalities are no longer a free lunch. They carry short and long-term costs for businesses.
For investors, the implications are even more profound. The rapid progress on measuring nonfinancial issues and the growing evidence that ESG factors are impacting performance and risk profiles is now spurring innovation across all asset classes. The emerging understanding that finance is no longer a black box guided by min-max strategies based on the efficient market hypothesis is shaking the foundations of the industry.
Second, there is emerging consensus that technology and digitalization are key drivers shaping the future of sustainable investing. Although the quantity and quality of ESG data remain unaligned—we have too much data of too little quality —it is clear that the ecosystem that defines the interplay between corporations and investors is producing a host of new technologies such as ESG-focused artificial intelligence and machine learning solutions.
Such technologies will strengthen the scientific and research-based underpinnings of sustainable investment decisions showing that ESG assessments can be based on patterns inherent in vast and complex data sets. Given that not all negative ESG incidents are reported in corporate disclosures, new technologies such as big data analyses reveal a more comprehensive picture of a firm’s sustainability performance.
What has to improve is the uptake of these new technologies. So far, only a handful of investment firms have directly embedded AI into relevant investment processes. The main barriers are not just costs and access to talent but also, and maybe most of all, a lack of vision.
Third and finally, sustainable investing not only promotes business resilience, by for instance preparing firms to recover from disruptive events, but is in itself a resilient investment strategy. Experiences gained throughout the Covid-19 pandemic seem to validate this: Sustainable investing has increased and shown good results vis-à-vis relevant benchmarks. Recently, Morningstar reported that 51 out of its 57 sustainable investing indices outperformed the market for the first quarter of 2020. The growing awareness around market vulnerabilities is changing long-term risk perceptions, and therefore putting a premium on innovation and adoptive flexibility.
The resilience of sustainable investing is likely to have many causes, some of which are not yet sufficiently understood. However, what is clear is that investors’ appetite for firms with a strong ESG track record seems to persist during times of unexpected market turbulence. This resilience is particularly shaped by investors’ focus on material ESG issues. While in the past sustainable investing was often limited to a broad-brush exclusionary approach, the focus on material ESG issues now allows investors to more effectively tie sustainability considerations to risk management.
The bottom line is this: We do not just need to redefine the purpose of the corporation as such, as argued recently by the U.S.-based Business Roundtable. Instead, we need to repurpose the core of investment strategies to promote and enable the renewal of markets from within.
Georg Kell is the founding executive director of the U.N. Global Compact and the chairman of Arabesque. Andreas Rasche is professor of business in society at the CBS Centre for Sustainability. They are the co-authors, along with Herman Bril, of Sustainable Investing: A Path to a New Horizon.