In the now-classic model of technology adoption, the most difficult step is expanding from aspirational visionaries to hard nosed pragmatists. Innovations that “cross the chasm” create a bandwagon effect and stand to become the new industry standard.
Financial institutions certainly seem to be jumping on the bandwagon of environmental, social and governance, or ESG investing.
On the latest edition of ImpactAlpha’s Returns on Investment podcast, host Brian Walsh suggests that the ‘technology’ of ESG and impact investing has passed the early-adopter stage and entered the early majority, gaining momentum among companies, asset managers and banks.
As ImpactAlpha contributing editor Imogen Rose-Smith notes, “The number that finance is paying attention is the $20.6 billion of inflows into ESG exchange-traded funds in 2019. That is a huge wakeup call to the industry.”
Under pressure from asset owners large and small, virtually every large asset manager is spinning up products that purport to factor environmental, social and governance data into investment decisions. Announcements have been flying fast and furious, capped by BlackRock CEO Larry Fink’s annual letter, which pledged the firm to move from traditional market cap-weighted indexes, which by default reward the largest companies, to indexes weighted by ESG factors.
Bloomberg reports that nine of the biggest U.S. ESG mutual funds last year outperformed the Standard & Poor’s 500 Index. The ranking “shows sustainable investing isn’t just for do-gooders,” the authors write. “It’s a money-making opportunity that’s gaining popularity.”
Climate risk is the point of the spear: The U.K.’s Brunel Pension Partnership, which manages $39 billion in assets, said last week it would terminate managers that don’t reduce the fund’s exposure to climate risk and shed portfolio companies that don’t cut carbon emissions.
System change?
ESG investing alone, of course, does not a better world make. Integrating non-financial factors into investment decisions may help investors avoid certain risks, but it doesn’t by itself drive capital or resources into needed solutions. A year ago, the podcast roundtable took up the same question, under the headline, “If ESG investing is so great, why is the world going to hell?”
“The hope is that what we’re seeing is a fundamental shift in how we think about capital and capitalism,” Rose-Smith said. “But if this doesn’t truly become integrated with finance and investing and the mechanisms of the capital market, then it’s effectively just an extension of marketing and communications.”
Looking at the market through the dynamics of technology adoption, however, suggests the shift may indeed be disruptive.
“All of a sudden, there’s a hiring frenzy going on, there’s a bunch of activity to get ahead of this thing they know is coming,” I offered in the podcast discussion. “That creates its own kind of race and competition. We’ve been saying sustainability is a disruptive force in asset management, just like tech was a disruptive force 20 years. And when you see the disruptive force coming, you scramble.”
That, the theory goes, creates a new class of investors and companies that have placed their bets on a more sustainable and inclusive future. “We’re getting to a reasonable minority of investors who now have considerable stake on that side of the ledger,” I argued. “There’s a constituency of capital, as well as a popular constituency. Take those two things together – top down and bottom up – and there’s a new kind of pressure politics around this more sustainable future, because it will make these bets pay off.”
For ESG and impact investing to really be a technology, more and better data is needed, Rose-Smith cautions. “What investors have not yet figured out is what is good high-quality information that is going to drive good high-quality investment decisions,” she says. “I think this is an idea that has taken root. I don’t think it’s yet a technology that has taken root.”
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