ESG investors betting on the wrong horses
Mark Hulbert says don’t be too harsh in investors whose only goal is profit. They might be key to providing more capital for greening global business.
(Mark Hulbert, an author and longtime investment columnist, is the founder of the Hulbert Financial Digest; his Hulbert Ratings audits investment newsletter returns.)
CHAPEL HILL, N.C. (Callaway Climate Insights) — If your goal is using your investment dollars to help create a better climate, then you should consider investing in companies that are big polluters.
That is just one of the surprising conclusions to emerge from new research into how socially responsible investors can maximize their impact on corporate behavior. Its authors are Martin Oehmke, a finance professor at the London School of Economics, and Marcus Opp, a professor of banking and finance at the Stockholm School of Economics. Though their study was only recently released, it has already received a lot of attention, especially in Europe — where it was awarded the “best paper in responsible finance” prize by the European Finance Association.
The professors reached their conclusions after studying the interactions between two groups of investors: Profit maximizers (who care only about monetary profit) and socially responsible investors (who care about both monetary profit and companies adopting cleaner technologies). The researchers analyzed the impact of these interactions on various kinds of corporations: At one extreme those that will pursue polluting technologies no matter what, to those at the other extreme that are committed to clean technologies.
It is these latter companies to which climate-focused investors typically gravitate. But that does little to improve the Earth’s climate, the professors argue. That’s because these already clean companies are likely to continue pursuing clean technologies regardless of whether you or I invest in them. Rather than changing the world, focusing our investments on such companies results in little more than the “warm glow” we receive for not profiting from polluting technologies.
If we truly want to clean up the world’s climate, then we should be focusing our investments in companies that are still sitting with the question of whether or not to go green. If cheap and plentiful socially responsible investment financing were made available to such companies, it might actually induce them to adopt climate-friendly technologies. Yet these companies could just as easily continue pursuing polluting technologies at the behest of investors who care only about maximizing profits.
We need to give up the false ideal of investment purity and focus instead on the complicated and often messy task of changing corporate behavior.
That means we need to give up the false ideal of investment purity and focus instead on the complicated and often messy task of changing corporate behavior. That involves hard choices and difficult cost-benefit calculations. We might be doing the climate more good by investing in an egregious polluter if, in the process, we nudge it in the direction of being less egregious.
That will feel a lot less self-righteous. But surely our goal is to create a cleaner climate than to pat ourselves on the back.
One financing mechanism that socially responsible investors can use to induce more climate-friendly behavior is the so-called green bond. This is debt that a corporation issues in return for a commitment to use the proceeds for a climate- and environmentally-friendly project. A recent example is a $1 billion offering last week from Verizon, which followed close on the heels of a similarly-sized offering from JPMorgan Chase the week prior.
The authors of this new study remind investors that such bonds will almost certainly be issued at a lower yield than otherwise comparable bonds which carry no commitment to green projects. That’s because, if the green projects would have otherwise provided the profit-maximizing return, then the companies issuing the bonds would not have needed to use the green bond structure to secure the necessary financing.
In that event, of course, socially responsible investors would be wasting their time with such companies, since their investments would have no effect on the companies’ climate-friendliness. Investors interested in improving the climate should instead invest in other projects that would actually lead to altering corporate behavior.
A corollary of this finding is that ESG funds need to be judged by more than their financial profit. If we want them to help change the world, then we must give them the broad leeway to underperform other funds that do not have an ESG focus.
The climate-friendliness of profit-maximizing investors
This discussion leads to another surprising result of the professors’ research: More money gets invested in climate-friendly projects when there is a mixture of both profit-maximizing and socially responsible investors. That’s for several reasons. One is that green technologies sometimes will be those that also maximize profits; in that event there will be plenty of financing available from profit maximizers. That leaves more socially-responsible investor capital available to companies that would otherwise not pursue the clean technologies.
In addition, according to the professors, the presence of ample financing from profit maximizing investors motivates socially-responsible investors to increase the amount of clean financing that they are willing to extend. That’s because, without that additional clean financing, the companies would likely choose to continue investing in less climate friendly projects.
So think twice before being too judgmental about investors whose sole goal is maximizing profit. Their presence might very well be leading to an increase in the amount of capital available to finance a green New Deal.