The Impact of the Seven Tribes
Realistically, what impact does sustainable investing have?
One of the more important questions of our time is how can investment actually help encourage positive sustainability and impact related outcomes and how can we all better understand the actual impact of investment across different strategies.
This essential conversation gets twisted up too often in a myriad of ways.
We helped establish that there are a distinct Seven Tribes of Sustainable Investing, which behave very differently one from the other, in our most recent book on the subject Sustainable Investing: Revolutions in Theory and Practice, yet there are many other attempts to differentiate between categories of strategy, or worse, more recent trends of calling the entire field of sustainable finance “ESG” as if that means something.
PLEASE PLEASE stop with that reference everyone, ESG is a series of many different issues, with accompanying risks and opportunities (not just risk, another frequent misunderstanding) and strategies vary widely among companies, investors, policymakers, innovators and consumers/voters to address these many issues and must be parsed out separately to be best understood.
The seven tribes in question are, of course, 1) negative screening, 2) positive/best in class, 3) impact, 4) thematic, 5) ESG integration, 6) shareholder engagement and 7) minimum standards, and all other attempts to categorize are merely a variation on these definitions, and so the differences among these schemes isn’t that relevant, even if a bit confusing, we have really do finally have some clarity on what is happening.
What impact then do each of these strategy categories have or could they have is the most important question to investigate as follows:
Starting with negative screening, this is where the entire field started, back up through the year 2000, when limited available data had firms like KLD gather whatever information they could on company violations, mostly in the US, and firms like Calvert constructed indexes which started with the S&P 500 as a universe and subtracted out a small number of the worst violators based on this ESG data of discovered negative performance. Up to the present time, such negative screening practices include calls for divestment from fossil fuel production.
Such practices often lead to worse negative financial results, such as in 2022 when oil companies did well after the Ukraine invasion, or back in 2008 when we looked at the entire field of sustainable investment global portfolios available to the public, and negative screening at best met market performance over the 1-, 3- and 5- years leading up to the end of 2007. The longest standing sustainable investment funds of Calvert and Domini have not outperformed benchmarks since inception, providing more evidence of financial concern of risk only, negative analysis over time and its effects on returns.
Negative screening while becoming a smaller percentage of sustainable investment practice overall used to dominate the field, and such observations of frequent financial underperformance, or at best market performance, have led many financial professionals to assume there is a negative implication to taking ESG issues into account in any way, and has been a barrier as a result to asset owner take up as well, as beneficiaries can challenge asset owners on not maximizing their fiduciary duty and so this is indeed a major hurdle to overcome.
Nor does negative screening cause companies for whom you sold stock in to simply go away. However, the ESG pushback, fostered by a growing number of US “red states”, and pushed by a few individuals and right wing foundations, is clearly evidence of concern about the potential longer term effectiveness of divestment. Attorneys General are using terms like “boycott” and otherwise seemingly arbitrarily choosing firms to not do business with as an outcome. It is important to note that in 2020 the price of oil went negative (which isn’t that long ago), and by early 2021 the fossil fuel production industry was stopping investment in future production as they could see where climate change concerns combined with their own financial struggles at the time was all going. (Side note: the “red state” pushback may well create stranded asset overweighting for their pension beneficiaries, becomes an important question to consider).
A clear conclusion then is that negative screening can have significant impact, if it reaches scale. However, the downside too often experienced by investors not only has given asset owners and other financial professionals pause, it has created a stigma that has helped limit investment dollars flow adequately into the sustainable investment space more generally, and so this is as we can see fairly complex. See item 7 on minimum standards below for more, but suffice it to say that this 1.0 of sustainable investment has arguably been more of an obstacle to progress than not given the limited percentage of assets deployed in general (and such reports on the actual size of the field have long been overstated, recently and finally corrected, which only leads to more skepticism - sometimes we can be our our own worst enemy if we aren’t careful).
All of which is why we encouraged more positive forms of sustainable investing in our books, starting in 2008, including but not only when it comes to investing in existing public companies. This doesn’t have to be limited to public companies (same with negative screening, much of the reason the US became the largest fossil fuel producing nation over the past decade is due to private investment, not public). Private equity, venture capital and even forms of state-owned or led enterprises can be a focus as well of more positive approaches. Systems thinking teaches that positive approaches work better than negative. Our 2008 book found that the more positively focused funds often beat benchmarks after fees. Firms such as Generation, Parnassus, Mirova, Stewart Investors, Brown Advisory and many more have attracted 20+ billion USD to invest using such strategies successfully for their clients. Much of the momentum in the past five years has been towards more positive strategies. None of the US “red state” pushback can touch this. In our classes, students choose such portfolios and also often outperform, even portfolios run by professionals, when focused on both sustainability and financial outcomes.
Yet there can be concerns here as well.
Does this form of sustainable investing lead to better societal outcomes is a reasonable question to ask. As with negative screening, achieving meaningful scale would have more impact, and in this case, there’s literally no concern on trying to maximize financial outcomes or create risk of concern from a fiduciary duty perspective. It is also fine to want to own companies you like and not own companies you find offensive.
You are what you eat has become you are what you own.
Imagine if this sort of movement, as we have seen towards sustainable consumption in recent years took more hold in investing practices writ large, especially as millenials inherit trillions of dollars going forward.
Expect it and encourage it.
This takes us to Impact Investing. Some call the entire field Impact Investing, but we believe this should be limited to investing in solutions for those less well off, such as access to financial resources, education, healthcare, housing and so on. Other definitions vary, and this field is now when defined properly approaching $1T USD in allocated capital.
Given that our own studies showed that the value of investment is roughly $500 Trillion USD (up from $450 Trillion in 2015), this is a very small percentage, and as a result we were early skeptics and remain somewhat skeptical of the potential for achieving scale with this method, but we are fascinated by the area now, and have helped perform the research for the GIIN to back their Clean Energy theme as part of their excellent Navigating Impact platform which everyone should use, whether to determine metrics or seek evidence and case studies. Speaking of case studies, the TPG Rise fund and their methodology are always worth a look.
However, there should be more focus on what areas of impact so-called impact investing can actually help with and not. If you are concerned with bringing farmers out of poverty and creating more ethically run businesses in agriculture while helping local communities in the process, this is a great way to do that, and that’s fantastic. Yet when it comes to climate change, due to the embedded nature of greenhouse gas emissions throughout companies supply chains and the international economy, impact investing will not on its own solve this challenge to be sure.
And so here we can see the impact of ones dollars, the number one thing investors said they wanted to better understand, but this can only help answer that question for some potential categories of impact, hence this article. As always we need to be much clearer eyed about what actually works, what can work and what is scalable and how. Impact investing can help solve some challenges and provides useful evidence on outcomes, but we should not overstate it’s potential to solve all ESG issues.
Thematic investing may be the most exciting and important area of all, renewable energy investment approaches $1T per year, while estimates call for 3-5 times that amount to solve climate change once and for all. There’s that scale issue again. Momentum towards GSS (green, social, sustainable) bonds in 2022 slowed. ESG pushback is largely focused on stopping efforts to steer lending towards sustainability oriented projects and away from fossil fuel. We are particularly encouraged by JTEPs in Indonesia and Vietnam, for example, where difficult to transition countries from a coal perspective get support from larger countries to make intentional transitions actually happen. We believe we also will have to find funding that doesn’t exist to make these transitions happen at necessary scale.
Countries such as India don’t have the money for the transition it knows it needs to make. Asset owners such as pension funds don’t have $50 Trillion USD just sitting around waiting to be deployed. We believe we will have to get creative on a global stimulus to make these transitions happen. More on this anon. In the meantime, banks and other financial institutions have been making projects happen to solve the SDGs through finance as we documented in our InvestNYC and the SDGs paper, featuring case studies of success including Goldman’s affordable housing with renewable energy built in as well as Scott Jacobs and Jigar Shah (now in the White House)’s Generate Capital, Dave Chen’s Equilibrium Capital and many others). Project finance can solve some of the challenges we face. The rise of Climate Tech VC and corporates such as Equinor moving towards offshore wind also helps. Innovation is an important pillar of what is needed, as is getting corporations to do more on this subject. But where will the necessary funding come from?
Most of the larger institutions, who manage the most of this funding are firms like Blackrock, and ESG Integration was the primary focus a few years ago. Every firm in the US during the pandemic was hiring, it was no longer acceptable to not have a solution when it comes to sustainability and impact challenges, as market share was (and is) at risk as millenials eventually do that inheriting. Yet in 2022 we had, righly so for the most part, pushback on greenwashing. DWS, BNYMellon, Goldman and Blackrock all have had a target on their backs from either whistleblowers or regulators. The head of DWS lost their job on the back of what Desiree Fixler’s experience helped bring to life, so this is now serious business.
The EU attempts to regulate this continue, with the SFDR rollout causing much consternation but also clearer focus on what is truly sustainable, even if a work in progress. Other claims proliferate and concerns about ESG data quality and consistency are clear. However, ESG data is useful, even if that utility has been largely oversold throughout the history of the field for many reasons. ESG data gathering lets companies know they are being observed. As a result, if large enough percentages of investors can know that DEI practices are unacceptable, or that companies are being overly damaging, harmful to communities or otherwise wasteful or abusive, they will be called out to account. Integrating gathered ESG data then becomes a very important check and balance on corporate practice which is all too often forgotten. ESG data won’t tell you who will win the race to build the electric, driverless car and truck of the future that the market will take to (Elon seems bent on losing market share, what is he doing, but anyway) or what countries can do to truly transition on transportation and electricity, but it is a useful input. We merely need to be clearer on what ESG Integration really means when it is specifically useful, and how not to oversell it for what it cannot and does not do.
This takes us to the other use case for ESG data and that is shareholder engagement and advocacy. Shareholder engagement use cases largely drove ESG data gathering in the first place, hence that use case is clear, and helps further ensure that that check and balance on corporate malpractice and abuse actually works. No wonder “red state” pushback often focuses on European firms who often vote against management, as this is another area where scaled effectiveness has come to the fore with board members shifting at ExxonMobil and potential for similar going forward through our previously envisioned Nature 100 with the World Bank. Advocacy by investors is also essential to be performed with policymakers, and to ensure companies do not lobby against such policies especially when it comes to issues such as progress on climate change.
Shareholder engagement is also essential for ensuring companies are governed properly, especially when they are not. A great book on this is Mark Mobius’s Invest for Good, filled with anecdotes on how to invest globally with corporate governance in mind, and engaging directly with companies you intend to invest in, becomes an essential component for investment success and encourages companies to do the right thing. This book is also an immediate refutation to the so-called “anti-ESG” movement. Asia is half of the world’s economy right now, or close to it. Are supposed to ignore governance when investing in half of the world’s economy and simply trust our money? That is simply a non starter and should be Exhibit A as to why the '“anti-ESG” movement will ultimately fail.
There are legitimate concerns as to how helpful shareholder engagement can really be, including in Asia, and especially if that is all you do as an investor, but this check and balance mechanism is an essential component of what is seemingly necessary, especially to let companies who shares are owned by mostly institutional investors, largely on behalf of their clients, know they are being watched and can’t get away with the absolute worst, especially in an age of ever increasing transparency.
Last but not least we have minimum standards. Our specific suggestion in late 2018 to the NY State Comptroller and his team during our Decarbonization Advisory Panel deliberations led to recommendations in 2019 and a climate action plan that continued to roll out succesfully in 2021 and beyond. Minimum standards were a way to bring together divestment and engagement advocates on our panel who were otherwise at odds on a concrete set of recommendations. Bevis Longstreth, one of our fellow panels, and a divestment advocate called this “better than divestment.” The Yale endowment implemented minimum standards on fossil fuel to help answer student sit ins and otherwise establish minimum thresholds of acceptable practice for companies, and codified this into its 1970’s still seminal Ethical Investor.
Climate Action Plans are now proliferating, including those recently announced by Norges Bank which for some reason hasn’t gotten that much attention. Norges Bank were arguably the original minimum standards practitioner, and everything they do is transparent. Imagine if every asset owner were fully transparent and had a Climate Action Plan. The potential for minimum standards across sector is clear, and minimum standards are also needed for the financial services sector itself, whether minimum percentages of green lending as is seen in China and as is being encouraged through the leadership of the likes of Dr. Ma Jun through the global central banker network.
In conclusion, there is a choice in these seven categories of strategy and financial implications to these choices as well. Investors can use none of these, one of these, some of these or all.
We would suggest some form of thoughtful all of the above is the right way forward for the sake of truly maximizing impact, while being clearer about what investment strategies are each trying to solve for more specifically, while also being mindful about what necessary scale looks like, working backwards from that and doing your part while being clearer on specific use cases for each strategy as well. Integrity, scale and creativity are essential.
We need to also more creatively actually find the trillions of dollars necessary to scale the impact of thematic investing and impact investing. Blended finance alone won’t do it, neither will groups such as the World Bank who just don’t operate in the trillions today. This will likely need a new instutition and a global consensus to act in this manner and we need to get on this straight away.
For existing investment, carving out more sustainable finance allocations is most essential, whether deployed through positive sustainable investing, impact or thematic as part of Climate Action Plans that all investors can deploy, using NYS Common or similar as an example.
All investing can apply minimum standards as well as the right forms of ESG integration combined with shareholder engagement to encourage the right practices. Minimum standards means divestment becomes baked into the financial process (which is buy, then hold while being responsible in the process, and then sell, not just sell directly). Interventions into existing investment processes at scale can do the trick and is indeed “better than divestment,” and better than simple case negative screening, but known what you own and own what you want.
Besides, as we concluded our first book in 2008, markets need winners and losers, we only need a majority to agree.
The fight for this global majority continues, whether in the streets of Sao Paulo yesterday, and in every country for what’s right for people, for nature and for society.