The Impact of Sustainable Investing

Written by MASECO Private Wealth

When investors shift their assets from a conventional strategy to a sustainable one, what happens? What is the impact? Are companies incentivized to behave more responsibly?  Do they then do so?  Or do they just make glossy sustainability reports so they look good?  We look at what the research shows, but first we examine the different ways that sustainable investors could make an impact.

How Investors Drive Change

A recent academic study, “The Impact of Sustainable Investing: A Multidisciplinary Review”[1], broke down the ways in which sustainable investors can drive change:

• Shareholder Advocacy and Engagement
• Field Building
• Portfolio Screening

The Role of Shareholder Advocacy and Engagement

Many sustainable investors expect their investment managers to engage with the companies in which they invest. Engagement takes many forms, but at its core it is an effort by investors to encourage companies to perform better on a particular issue.  The investors in a company are the actual owners of the firm so they do have influence over it.

Often investors want companies to be more transparent by disclosing their performance on environmental, social, and metrics.  They also ask for improvement on those metrics, such as reducing emissions, or boosting employee satisfaction, or diversifying the board of directors.

Most public companies have an investor relations department. Their job is to present the company in the most favorable light possible so that it is more attractive to investors. Historically, this was all about making a financial case. But investment managers are starting to ask questions about how the company is doing for people and the planet, in addition to profits. Sustainable investment managers start with tough questions and then use several approaches to encourage companies to do better. These efforts generally start out friendly and then increase in pressure. They include, ranked from low commitment to high:

• Letter-writing
• Proxy voting, with an explanation
• Meeting with company representatives
• Group dialogue
• Sign-on letter
• Meeting with the board or CEO
• Filing a shareholder resolution
• Book and records request
• “Vote No” campaign against directors
• Running a candidate for the board
• Lawsuit

Most companies don’t want lawsuits. Most board members prefer to keep their positions. And dealing with a shareholder resolution is quite taxing for a public company. If the investor request is reasonable, most companies would rather acquiesce than fight it to the end — especially when many of their peers have already begun doing what the investors are asking. It’s difficult to claim an inability to report greenhouse gas emissions when thousands of public companies already do so.

Public company ownership is usually dispersed across thousands of shareholders, few of which hold more than a fraction of a percent of the company. Investors and investment managers can amplify their influence by forming and joining coalitions. Some of these coalitions focus on direct engagement at the company level while others push for regulatory changes or standardization in disclosure.

An example of these coalitions is the Climate Action 100, an investor initiative to ensure the world’s largest corporate greenhouse gas emitters take action on climate change. F700 global investors with a collective $68 Trillion in assets under management are engaged in this initiative. The size and breadth of that coalition makes it hard for companies to ignore their requests[2].

The Role of Field Building

Investing in a sustainable fund over a conventional one is much like purchasing any green product — the laws of supply and demand apply. When you ask for a sustainable investment solution from your financial advisor, they notice, and so does your bank, brokerage firm, or custody platform The sustainable investor is sending signal to the marketplace that there is demand for sustainable investment products. When more investors signal their intention to invest sustainably, investment managers launch more products in the space, making it easier for further investment: Through their actions, sustainable investors act as catalysts for others to do the same. And competition in the space leads to lower costs, creating more demand — and a virtuous circle evolves.

While sustainable investing is growing rapidly, we are still at an early stage. Sustainable investors are joining growing cohort of investors who seek positive change. The percentage of investors asking for sustainability goes up every year. The financial services industry is responding by building out more capacity for investment managers to invest in this manner.

Sustainable investors tend to pay a bit more in management fees. These fees pay for the research, the data, and the systems that go into selecting more sustainable companies. This has become a big business. Gone are the days when ESG research was done primarily by nonprofits, academics, and small think tanks. The largest market research companies, including MSCI, Morningstar, Bloomberg, Reuters, and S&P, have bought up many of the early entrants. They have also developed in-house capabilities. As more and more investment management firms buy this research, it funds further development, thus forcing the data to get better and better. Five years ago, a minority of public companies reported their environmental, social and governance performance.  Today a majority do, so it is easier than ever for investors to make distinctions between companies on sustainability performance. This has important ramifications for those companies.

The Role of Portfolio Screening

Portfolio screening is the process of including or excluding certain companies from investment portfolios based on certain metrics.  Conventional investing focuses on financial criteria, like the company’s size or relative valuation compared to others. Sustainable investing uses those financial criteria as well, but then adds screens for environmental, social, and governance issues.  Screening is a way to raise or lower the demand for a company’s stock.

The earliest sustainable funds focused on negative screening.  They would exclude companies that violated certain principles like human rights, fair treatment of workers, or that operated in certain business lines, like tobacco or weapons.  Today negative screens can be quite sophisticated, and include ways to eliminate companies that are highly exposed to climate risks like sea level rise or drought, or exclude the set of companies that have the highest emissions per dollar of revenue in their sector.

More modern approaches now include positive screening.  This approach seeks to include companies in portfolios if they are doing certain things well.  Fund managers might seek out companies that are reducing emissions the fastest, building renewable energy capacity, providing a great place to work, or fostering healthy communities.

Companies that score well on environmental, social, and governance criteria are increasingly rewarded by being included in more portfolios. This increased demand can lift their stock price.  On the flip side, the companies that score poorly are punished by being excluded from more portfolios.  Their stock prices can suffer. Academic studies that research these effects show some correlation between better ESG scores and higher stock prices.  These ‘cost of capital’ studies might not be able to prove causation, i.e. that it was the higher ESG scores themselves that caused the higher price, rather than other factors. But the implication is clear for company management. If they want more investors, they should perform better on sustainability. If they are laggards, they will be excluded from some portfolios.

MASECO’s Approach

There is a mounting body of evidence that the sustainable investing preferences of investors are having a positive impact on the behaviour of companies, providing them with the incentive to improve lest they be at a competitive disadvantage to their peers.  Companies want to be attractive both to investors, but also to employees – they need the ability to attract and retain talent. Studies show that more companies can attract a broader set of investors and a more passionate workforce when they go sustainable.  These findings provide further support for the trend toward increasing shareholder activism related to sustainable investing objectives.

With that said there is also evidence that some SRI and ESG funds do not appear to walk the talk by investing in more sustainable companies. This raises questions about what exactly buyers of self-labelled ESG or ‘socially responsible’ mutual funds are getting in exchange for higher management fees. The bottom line is that investors should perform a thorough due diligence on a fund before considering investing. 

This is what we do at MASECO. Our starting point is that our sustainable fund choices cannot compromise on financial performance. We expect their returns to similar or better than conventional funds. Then our due diligence process makes sure we are not investing in funds that are greenwashing, or making claims they cannot substantiate.  Sustainable investing is not a cure-all for all the myriad issues the world is facing. But we believe investors can use their voice, as the owners of companies, to encourage companies to be part of the solution, rather than part of the problem.

[1] https://onlinelibrary.wiley.com/doi/full/10.1111/joms.12957 , 18 October 2023
[2] https://www.climateaction100.org/whos-involved/investors/ , 18 October 2023

Use of information

• Nothing in this document constitutes investment, tax or any other type of advice and should not be construed as such.
• The investments and strategies noted in this document may not be suitable for all investors and making available the information in this document is not a representation by MASECO that any investment strategy is suitable for any particular client.
• This document is provided for information purposes only and is not intended to be relied upon as a forecast, research or investment advice.
• This document does not constitute a recommendation, offer or solicitation to buy or sell any products or to adopt a particular investment strategy.

Risk Warnings

• All investments involve risk and may lose value.  The value of your investment can go down depending upon market conditions and you may not get back the original amount invested.
• Your capital is always at risk.
• Although the information is based on data which MASECO considers reliable, MASECO gives no assurance or guarantee that the information is accurate, current or complete and it should not be relied upon as such.
• The environmental, social governance (ESG) considerations in sustainable investing may affect the ability of product providers to invest in certain companies or industries from time to time.
• Investment results of portfolios that do not apply similar ESG considerations to their investment process may differ.
• To achieve sustainable investing, a product provider may need to:

1. limit the types and number of investment opportunities available to the product and, as a result, the product may underperform other products that do not have an ESG focus; and
2. concentrate investment in specific sectors, countries, currencies or companies and exclude others resulting in a product that may be more sensitive to any localised economic, market, political, sustainability-related or regulatory events.

MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is established as a limited liability partnership in England & Wales (Companies House No. OC337650) and has its registered office at Burleigh House, 357 Strand, London WC2R 0HS.  For your protection and for training and monitoring purposes, calls are usually recorded.

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