ESG: People are not perfect

The two main approaches to sustainable investing – exclusion and integration – force investors into one single prioritization of their preferences. To realize its true potential, ESG must move toward developing personalized investment products that enable targeted engagement.

Simon Smiles

Deutsche Version

Covid vaccinations are now available and underway in many countries. From a societal perspective, this is a critical step in fixing the current global pandemic. But not everyone is personally willing to be vaccinated.

Polls suggest 40-50% of Americans will not get a Covid vaccine when it first becomes available to them. One in three French people think vaccines in general are unsafe and 46% say they will reject a Covid vaccine. And more than 40% of people in Poland and Hungary also say they would reject a Covid vaccine if offered.

People instead have their own views on what, and what does not, make sense to personally do.

In investment, this is also true, yet sustainable investing's two main approaches, exclusion and integration, typically do not take individual's own views into account. As Barbara Novick, vice chairman and co-founder of BlackRock has been quoted by Bloomberg as saying: «If you throw everything in one big bucket, nobody really knows what you’ve got.» Hence to reach its true potential, sustainable investing needs to personalize its approach.

Arbitrary Exclusions

Exclusion simply removes specific types of companies, typically alcohol, weapons, tobacco, gambling, and adult entertainment from all portfolios, despite many investors personally consuming one or more of these products.

In 2010, close to 95% of adults in France had drunk alcohol in the preceding year, while 89% had in Switzerland and Denmark, and 84% had in Australia and the UK. According to Wikipedia, in the US there are 120 civilian guns per 100 people. US citizens have a specific constitutional right to bear arms. And guns are sold in the US's largest retailer Walmart, who just reversed an earlier decision from 2019 to stop selling them.

And with 42 billion (with a «b») visitors uploading 1.36 million hours of new content in 2019, the adult site Pornhub claimed one would have to start watching the new videos in the year 1850 to be finished by the end of 2019. Yet this usage accelerated even further when Covid broke out in 2020 – there was a worldwide increase of 11.6% in the week to March 12th, with traffic from Italy, the first European country to put a nation-wide quarantine into effect, experienced a 57% increase.

No Panaceas

Meanwhile, integration uses aggregated combinations of various environmental, social, and governance factors to rate companies across all sectors and regions. But unlike the vaccinations now available to help solve the specific Covid-19-pandemic, no single investment can positively, let alone materially, impact every environmental, social, and governance area as sustainable investing ratings currently imply.

Individuals anyway have their own personal views on which environment, social, and governance factors matter most, and least, to themselves. According to Raconteur, the «Top Themes of Interest» are plastic reduction and climate change (both indicated by 46% of respondents), followed by a range of other themes including community development (42%), multicultural diversity, and gender diversity (both 30%). Not only are these different, but they also have different peculiarities to one another, and no individual theme comes even close to having universal interest. In addition, specific themes typically have fundamentally different investment implications.

This is also apparent at a government level. New Zealand Prime Minister Jacinda Ardern leads a small country, yet has made highly justified headlines as a leader who became a mother while Prime Minister, took her baby to the UN General Assembly with her husband acting as primary care giver, showed world renowned empathy after a domestic terror attack, appointed one of the most truly diverse cabinets post her recent re-election, and has been universally commended for her Government's reaction to Covid, making the people she represents one of the least impacted by the global Covid pandemic.

Yet teenage climate change advocate Greta Thunberg recently criticized a lack of action by the Ardern government in a climate emergency declaration on Twitter, forcing a concerted government rebuttal despite Greta being Danish rather than Kiwi.

Targeted Engagement

Hence, to reach its true potential, sustainable investing needs to personalize its approach. Two examples are mass customized ratings and targeted engagement.

An investor’s sustainability preferences (self-selected as low, medium, or high) across multiple different issues could be captured and combined with simplified and consistent company sustainability data, screening equity and fixed income instruments to produce a client-personalized hierarchy of potential investment instruments. In this approach, investors A and B may have completely different appetites for stock ABC because each has very different sustainability preferences.

Second, dedicated, specific-cause-focused engagement funds can focus on specific environment, social, or governance issues that correcting would drive business success, while also having a material, real impact, not overall scattergun box ticking. Most listed-equity strategies, particularly in highly liquid markets, typically cannot demonstrate measurable impact. The market’s liquidity and efficiency prevent buying and selling a company’s stock from affecting it in any material way.

Instead, an engagement focused strategy should focus on where additional impact is likeliest to generate outsized societal and financial results – small-cap equities, especially in emerging markets, offer the most potential, while achieving positive impact is more challenging in large-cap companies with multiple stakeholders and in the probable presence of a large existing sustainability team.

People are people, not perfect. We all have our own perspectives. Hence, to reach its true potential, sustainable investment needs to move from imposing and prioritizing preferences, to personalized investment products that utilize mass customized ratings and thematic targeted engagement.

Zur Person

Simon Smiles
Picture: Bloomberg

Simon Smiles

Simon Smiles retired from UBS last year after more than 15 years. Most recently, he was Group Managing Director and CIO for Ultra High Net Worth Clients, establishing and running the wealth management sustainable and impact investing teams. Simon was a IIF Future Leader, WEF Young Global Leader, and a member of the Milken Institute's Young Leaders Circle. Simon received a PhD in economics from the Australian National University and first-class honors in both economics and finance from the University of Sydney.