Research: 71% of Fund Managers Make ESG Decisions Contrary to Their Preferences
ESG Influences Stock Selection But Returns Mostly Come First
Highlights of the Survey
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In the recently issued study, “Sustainable Investing, Evidence From the Field,” “Fund mandates, firmwide policies, or client wishes caused 71% to make stock selection, voting, or engagement decisions that they would otherwise not have. Some of these actions had financial consequences, such as avoiding stocks that would improve returns or diversification; others had ES (environmental/social) consequences, such as avoiding stocks whose ES performance they could have improved.”
ESG Influences Stock Selection But Returns Mostly Come First
The study authors are Alex Edmans, Professor of Economics and Tom Gosling, Executive Fellow at the London Business School, and Dirk Jenter, Professor of Finance, London School of Economics. Edmans is author of the recent book, May Contain Lies. They say that they surveyed 509 equity portfolio managers from both traditional and sustainable funds on whether, why, and how they incorporate firms’ environmental and social (ES) performance into investment
decisions.
The survey found that “ES performance influences stock selection, engagement, and voting for over three quarters of investors, including nearly two thirds of traditional investors. Financial considerations are a primary reason, even among sustainable funds. Few are willing to sacrifice financial returns for ES performance, largely due to fiduciary duty concerns, and voting and engagement are mainly driven by financial considerations.”The authors note that since 2006, when the United Nations established the Principles for Responsible Investment (PRI) signed by 63 institutional investors managing a total of $6.5 trillion, the level of commitment had grown to 4,841 investors with $121 trillion under management by March of this year.
Highlights of the Survey
- ES considerations rank near the bottom of investment factors considered with investment decisions. When asked “to rank the importance of actual ES performance (not ratings) on long-term firm value relative to five other value drivers: strategy and competitive position, operational performance, corporate culture, governance, and capital structure, ES performance received the lowest average support: 73% ranked it fifth or sixth, and its average ranking was lowest even among sustainable investors.” The authors note that ES ranks significantly below governance (G), “even though ESG factors are often bundled together; below corporate culture, another intangible; and below capital structure, even though the latter is irrelevant in perfect capital markets.”
- On the other hand, “85% (including 78% of traditional investors) rated at least one ES issue as material. Both investor types view ES performance on employee and consumer-related issues as most important, potentially because they are internalized even in the absence of regulation. More sustainable than traditional investors view environmental issues as material.”
- According to the survey, 73% of sustainable investors expect good ES performers to deliver positive alpha, and a notable 45% of traditional investors agree. Unexpectedly, by far the most popular reason is that ES performance is correlated with other factors that improve shareholder returns, rather than mattering directly. The second is that ES is directly valuable, but the market fails to price it in. Investor short- termism and unawareness of the financial materiality of ES are seen as more important than insufficient information.”
- 61% (67%) of traditional (sustainable) investors predict negative alpha from poor ES performance, suggesting “that some traditional investors view ES as a hygiene factor, where poor performance matters more than good.”
- As for selecting stocks, “77% of investors (66% traditional, 91% sustainable) often or very often incorporate ES performance into stock selection. “For sustainable funds, the fund mandate is most important, followed by alignment with client values, and firmwide policies. These three constraints rank higher than to improve fund returns or to avoid downside risk.” For traditional funds, the two financial reasons are most important. “Despite these differences, financial reasons cause a majority of both investor types to regularly incorporate ES performance into stock selection: 74% of sustainable and 51% of traditional investors do so to avoid downside risk, improve returns, or reduce volatility. Avoiding downside risk is a more common reason than improving expected returns.”
- 27% of investors responding to the survey (24% traditional, 31% sustainable) have voted for a shareholder proposal that was even slightly negative for shareholder value, even though 78% have supported value-neutral proposals, according to the survey. “Such voting, especially for negative value proposals, is driven more by ES constraints than the proposal’s expected impact on society.”
- 76% of investors (64% traditional, 92% sustainable) have engaged with companies to improve their ES performance, based on the survey. “Such engagement is motivated primarily by the expected impact on shareholder value, followed by the issue’s importance to clients, the firm, and wider society. Marketing motivations, such as concerns for the fund’s sustainability rating and reputation, are seen as least important. The main reasons why some investors never engage are their small stake and the costs of engagement, consistent with standard cost-benefit analysis.”
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