• While the study by Raghunandan and Rajgopal is disheartening, the evidence still suggests that overall, sustainable investing is working. In fact, the research reveals that sustainable companies enjoy lower systemic risk and have higher PE ratios, better cash flows, happier workforces, happier stakeholders and more transparent governance structures. They also generally make better long-term decisions. In the years 2018 to 2020, sustainable investment increased to $12 trillion, while the carbon footprint of all major index companies declined by approximately 30%. While we’re not suggesting there’s a direct causation, certainly the desire for more sustainability by investors (and consumers), has contributed to this trend. In other words, the tide has shifted in such a way that companies now know what investors and consumers seek—and are moving toward giving it to them.
• Engagement is also important. The evidence suggests that when companies engage with shareholders and managers to improve their sustainability metrics, they see an outsized performance return of 2.3% in the year of engagement and a 7.1% increase year over year (according to a study called “Active Ownership,” by Elroy Dimson, Oğuzhan Karakaş and Xi Li that appeared in a 2015 issue of the Review of Financial Studies). While this study is older, the conclusion is not surprising. It makes sense that companies will see improvements in their operating performance and profitability following such engagements since they will be able to attract positive press and social media attention. This in turn attracts more socially conscious investors and consumers.
What Does It Add Up To?
Now that I have reviewed the research, my biggest takeaway is that ESG investing is working to change corporate behavior while at the same time providing returns that are comparable to those of other companies when risk-adjusted returns are taken into account.
Caution is required, however, since investors who want to align their investments with their values must conduct adequate due diligence if they are looking at a company’s ESG rating. Without consistent metrics, standardization or regulation, investors could overlook evidence of companies’ (and especially mutual funds’) greenwashing. They should take nothing at face value, and more important, when they rely on ratings, they should turn to agencies whose metrics align most closely with their own. For instance, if the environment is the most important thing to them, they should find a ratings agency that more heavily weights environmental criteria.
Fundamentally, I still believe corporate earnings will be the primary driver of the price of a stock, but the risk premium argument is interesting, nonetheless. Companies that consider factors such as their employees and the environment while also providing shareholder value will necessarily fare better given their lower systemic risk, but they may also be more sought after simply because consumers like them better. This makes ESG not only sustainable investing but good investing, if we’re speaking from a strictly capitalist point of view. Even Milton Friedman, the prominent advocate of free-markets and monetarism, suggested over 50 years ago: “It may well be in the long-run interest of a corporation … to devote resources to providing amenities to [its] community or to improving its government. That may make it easier to attract desirable employees, it may reduce the wage bill … or have other worthwhile effects.”
Now, the question that started this article: Is ESG investing to blame for the skyrocketing price of oil?
It’s clear that with or without ESG investing, the price of oil would be rising given world events today. It’s a simple issue of supply and demand. The world continues to be oil dependent, while the production of oil here at home has been reduced. It’s not ESG investing per se that’s making us reduce our reliance on oil while moving toward cleaner energy; it’s the result of an ongoing movement toward sustainability. Today, two-thirds of Americans believe we should take steps to become carbon neutral by 2050. Similarly, two-thirds believe we should use a mix of oil and alternative fuel sources in the long term, as opposed to doing away with fossil fuels entirely (according to a Pew Research Center study conducted in 2022). On the tail ends of these statistics are the Americans who either believe we should do away with fossil fuels entirely or that we should move to expand oil, coal and natural gas production. These vocal minorities contribute to most of the political gridlock dividing our country.
Note that these Pew survey results were collected in January 2022, before the Russian invasion of Ukraine. It’s possible these numbers have shifted some since the invasion, though there is also evidence that the oil crunch has more Americans interested in electric cars.
Either way, the price of oil will eventually stabilize. And the movement toward sustainable investing will also likely continue. In fact, a recent study conducted by Deutsche Bank suggests the percentage of assets invested sustainably worldwide will rise from approximately 50% in 2020 to 95% in 2030. At that point, sustainable investing will be part of all investing, making this discussion moot. For now, however, it’s important to keep in mind that ESG is simply a mechanism, one of many, to express a point of view that has been embraced by much of the country.
Haleh Moddasser, CPA, is a senior wealth advisor at Stearns Financial Group.