To jump-start sustainable investing, make sure investor goals are aligned, refresh outdated mental models, and standardize how impact is ranked and measured.
What’s been happening over the last 20 years — and really accelerating over the last five years — is that investors are starting to consider the social and environmental impacts of companies as being important to their own return. Capital markets are moving very fast to try to incorporate social and environmental performance into the way companies are valued and the way that investors take action.
However, there are three obstacles standing in the way of that momentum.
Hurdle 1: Misalignment in the investor community
Big asset owners who shape the markets are complicated — they’re organizations or multiple family members who, across generations, might have different perspectives, and we know that younger generations are more concerned about social-environmental issues.
The same is true within endowments, with multiple stakeholders who have various priorities. A key issue going forward will be how to align social priorities with those various investment objectives. Will organizations are willing to take more risk or less return to achieve greater impact?
There are different beliefs about whether it’s possible to break these tradeoffs, and there’s a whole set of conversations that have to happen within asset-owning organizations before there’s really consistent action and consistent voice from the investor community that would shape the business world.
Hurdle 2: Outdated or inaccurate ‘mental models’
Assuming stakeholders are aligned on wanting to use their money for social causes while making a good return in the process, a bigger problem emerges: How to do it. It is concerned that people’s perceptions — or mental models — about how investment actions can affect change are inaccurate. Common mental models include “anything I do as an investor affects anything a company does” and If I want to make a better world, I should just sell bad stocks and buy good ones.
These beliefs are false.
If you look at the data, unless you’re a very prominent, highly symbolic institution, divesting from a stock doesn’t really change anything about how that company is going to behave with your minor meta.
Change comes more consistently from owning stock and participating in shareholder engagement that pushes management to change their behavior.
Also impactful? Providing capital to things that no one else would — things like very early-stage financing of climate technology, or angel investing, or micro-financing community entrepreneurs.
However, even if investors are properly focused on shareholder engagement and providing additive capital, it’s essential to think carefully about the system you hope to influence. Take climate change. Many people might look to solar panels or renewable energy as solutions.
Building a nuclear station or a solar field doesn’t automatically shut down a coal plant. You could be running both of them at the same time. It turns out that investment actions that stop new coal plants, that shut down coal mines, that make our infrastructure more energy efficient so that it uses less energy and stops burning those fossil fuels now, are much more bang for the buck. They’re much higher leverage. For example, investment in services and technologies for the weatherization of low-income housing can create a triple benefit — financially, socially, and environmentally.
In the case of climate, By planting trees, We’re opening up the drain — but if we still gushing the faucet of burning fossil fuels, the sink is still going to keep filling up.
Hurdle 3: Inconsistent measurement
It’s essential to measure success and progress, but this can be a huge challenge due to faulty reporting and rating agencies with methodologies that are noisy and opaque.
Why? One, there’s no consistency in the reporting or the gathering of data about firms’ ethical behavior or environmental, social, and governance (ESG) data. Different companies are reporting this information in different ways, and with different levels of rigor.
ESG rating agencies aggregate this information to produce ratings and rankings but have massive disagreement even on past behavior and present policy, let alone future behavior. Moreover, investors are expecting companies to work toward many goals at once. We end up with what we call aggregate confusion, which is problematic.
Gradually, we can get to a place where the capital markets are able to reward firms for ethical behavior and deal with social and environmental harm, but there is a lot of work to do.