Pursuing responsibility and returns simultaneously

The relationship between the social and financial performance of companies is one of the most central debates in corporate responsibility literature. As outlined in Chapter 2.6, this CSP-CFP debate concerns whether responsibility (CSP, corporate social performance) and returns (CFP, corporate financial performance) can be pursued simultaneously, and which of the two causes the other. Analyzing investors’ views on the debate helps understand why they do or do not apply certain practices of responsible investing, given that the financial imperative created by fiduciary duty binds them to follow return targets. The varying opinions of investors on the issue are collected in Table 8.

Most investors support the proposition that CSP can improve CFP – that it is possible to pursue responsibility and returns simultaneously. As the quote from one investor

illustrates, most investors are hence confident that pursuing responsibility does not hinder but actually helps generate returns:

“If you can answer the global challenges of today… then I believe that in addition to saving the world, I believe that you will also win as a company.” (Atlas)

Table 8: Investors’ opinions on pursuing responsibility and returns (the CSP-CFP debate) simultaneously

“If you can answer the global challenges of today… then I believe that in addition to saving the world, I believe that you will also win as a company.” (Atlas)

Investing responsibly does not compromise risk-adjusted returns

“We believe that we don’t at least have to compromise returns [when investing responsibly].” (Theia)

“… if you exclude some sectors from your investment universe, then you give away the free lunch of the market –

diversification.” (Crius); “If… active management costs more due to [responsible strategies], there will likely be

underperformance.” (Helios)

The debate stems from ambiguous definitions and poor measures

“You can get any evidence to support both main arguments by data mining”. (Mnemosyne); “Here we return to the

terminology and what we mean by responsible investing. --They might have defined responsible investing as excluding a few industries and that’s it.” (Atlas)

The debate stems from a false dichotomy, there are no separate responsible investments

“… the management doesn’t need any kind of ESG agenda because [it] is obliged to do everything that helps the company forward.” (Helios); “We have… a philosophical definition problem which is the bucket of ESG issues. It is getting

emptier, but we still think that it is separate from “Investment”

[sic] somehow. That task is not to create something new or additional which is responsible investment but to change investment itself.” (Themis)

Particularly, most investors think that this argument applies in the long run. In other words, they argue that irresponsible “sin stocks” might generate better returns in the short run (i.a.

because responsible investors might have diluted their price by divesting), but this anomaly will vanish in the long run:

“In the short run you can deliver higher returns by cheating etc., but in the long run the only way of delivering high returns with low risk is to have a well-run company.” (Tethys)

“There’s also some evidence that sin stocks would perform well but that might be because so many have rejected them. But that’s not sustainable, it’s just an anomaly that will fix itself when it’s been noticed.” (Rhea)

Moreover, some investors also note that not only the level but also the momentum of responsibility perception (in practice the responsibility ratings), can be a source of outperformance:

“You can make ESG investments in so many ways: the best ones, the ones whose ratings are rising… For instance, currently it seems that one can outperform by investing when the ESG momentum is positive. No matter how bad it actually is.”

(Mnemosyne)

Some investors take a bit more cautious position by stating that even though one might not be able to yield outperformance with responsibility, one does not, on average, have to compromise returns, either:

“The majority of academic studies state that they [responsible investments] yield at least as well as ordinary ones, not at least less. Of course, some studies report much better and some much worse results. One has to also remember that not all responsible investments outperform.” (Eos)

“We believe that we don’t at least have to compromise returns [when investing responsibly].” (Theia)

Not all investors, however, agree on the argument that responsibility and returns can be pursued simultaneously. One central, but also debated argument rationalizing this view is that responsible investing requires active investment management, that is likely to eat out any possible extra gains that responsible investments may yield:

“There is very solid evidence one cannot outperform with active investment management in the long run. Active management can work for some very special niche market. -- I don’t have any thoughts that responsible investing as an

umbrella term would yield outperformance. If… active management costs more due to it, there will likely be underperformance. There might be momentarily outperformance through liquidity effect but that will always be followed by momentarily underperformance if the underlying business logic doesn’t change.”

(Helios)

This argument is opposed by some investors, who, on the contrary, believe that active investment management can be consistently used to yield outperformance. What is more, as one investor argues, asset managers might still themselves perform better with active responsible investing strategies, given that the their own business logic is based on fees from clients who might value pursuing responsibility for its own sake:

“We saw a lot of assets drifting towards passive investment post financial crisis and that was because of a breakdown in trust. People just stopped believing that active investment management is worth anything. Why would you pay big fees if you don't get anything back? Responsible investment is a great response to that…

because it gives a shared purpose with the clients in a sustainable outcome.”

(Themis)

A second argument for the view that responsible investments, here particularly ethical screens, cannot outperform, relates to the fact by restricting one’s investment universe, diversifying one’s portfolio becomes harder and hence risk-adjusted returns will decrease:

“It’s very basic investment theory that if you exclude some sectors from your investment universe, then you give away the free lunch of the market – diversification – and the expected value of our returns decrease.” (Crius)

This argument too, however, comes with counterarguments. First, some investors note that it only applies to exclusionary screening but not to any other responsible investing strategies. Second and third, they argue that the potential decrease in the investment universe is very small and can be mitigated by creating synthetic financial products that mimic the properties of the excluded stocks. As this investor states:

“The only argument is that [responsible investing] would decrease it [risk-adjusted returns] an ethical, i.e. exclusionary strategy. -- If you look at how much is the exclusion of the [investment] index space… it’s typically 1,5%-3%, depending on the market. -- Now, if you exclude tobacco… you can buy synthetic tobacco companies, i.e. look at the factors of which the tobacco companies consist. -- You can mitigate the theoretical problem of exclusion by that.” (Mnemosyne)

On the other hand, many investors also note that the whole debate about the causation between responsibility and returns is only as high in quality as the comprehension and consequent measures of responsibility. That is, as these investors argue, you can derive results supporting any of the aforementioned stances depending on how you have defined and measured responsibility:

“You can get any evidence to support both main arguments by data mining”.

(Mnemosyne)

“Here we return to the terminology and what we mean by responsible investing. -- When you look at it in more detail, they might have defined responsible investing as excluding a few industries and that’s it.” (Atlas)

Finally, some investors argue that the whole discussion about responsible and “normal”

investments is a conceptually flawed one. These investors argue that making the distinction of responsible investments as a somehow separate category, is based on a flawed mental model, and partly contributes to the lack of adoption of truly responsible investment practices. They state that we should not really think about responsibility as any more special information than any else additional information supporting investment decisions:

“If it really is so [that ESG brings valuable business opportunities], the management doesn’t need any kind of ESG agenda because management is obliged to do everything that helps the company forward. It can be part of the strategy if we believe that it helps develop the business in the long run. If… not, then it won’t stick for long. Of course, responsible stock can outperform, as can any other stock.”

(Helios)

“We have kind of a philosophical definition problem which is the bucket of ESG issues. It is getting emptier, but we still think that it is separate from “investment”

somehow. That task is not to create something new or additional which is responsible investment but to change investment itself. -- I think this is what we’re moving away from, I hope so. The question has behind it the belief that by undertaking responsible investment we are necessarily constraining the opportunity set to the detriment of the investment returns. -- The newer understanding of this is that you can do better as an investor by attending to sustainability themes, and investors have started to do this because they have to.

Therefore, we are transforming investment management and it’s transforming right now to become sustainable and responsible in the true sense. -- Your question supposes that there is a constraint, but that constraint isn’t real, it’s an illusion. A belief that needs to change and has started to change.” (Themis)