In his paper “The Case Against Social Responsibility,” Robert Reich wrote that the corporation “must, for competitive reasons, resist doing anything that hurts—and will place a very low priority on anything that doesn’t help—the bottom line.”
The labor secretary under U.S. President Bill Clinton cited the following examples to support the view that business must first make a profit, not engage in socially beneficial acts alone.
- McDonald’s uses humane slaughtering methods—reducing costly injuries and yielding more meat.
- Walmart’s fresh produce “green” packaging (transparent wrap made from corn sugars) is cheaper than petroleum-based alternatives.
- Starbuck’s offers health insurance to U.S part-time workers—reducing turnover and training costs.
In Canada, Cisco’s goal to reduce two-thirds of business travel over several years illustrates that what is good for the environment can be good for profits, too.
In light of Nobel laureate Milton Friedman’s declaration that “the business of business is business,” one might ask if these efforts evidence shareholder value, true corporate social responsibility or simply good marketing.
There is no doubt that environmental, social and governance (ESG) labelled assets are growing. In early 2019, more than $20 trillion was invested globally in ESG assets; more than $11.6 trillion of that was in the U.S., representing one-quarter of the country’s professionally managed assets, according to the Harvard Business Review. Further, three-quarters of U.S. asset managers offer a sustainable investment option, according to a Morgan Stanley and Bloomberg survey.
In Canada, more than $2.1 trillion is invested in socially responsible investments, according to the Responsible Investing Association (RIA).
Growth has been rapid but questions remain. Why is responsible investing so popular? Is corporate behaviour really impacted? Is there a performance cost to investors?
A separate Morgan Stanley survey found 84% of millennials consider ESG factors to be a central investment goal.
Millennials are twice as likely as baby boomers to have an interest in companies solving social or environmental problems and to think that good ESG practices make better long-term investments, according to the RIA. An RBC survey found more than two-thirds of Canadian investors believe ESG can help mitigate risk. Perceptions drive marketing success and the financial service industry’s focus is on selling products. But what about investment performance?
As a trustee for foundations and pension plans, I was always wary about restricting the list of securities from which a portfolio manager could choose. I believed that maximizing the rate of return should be the only goal. This was short-sighted. Hospitals, it can be argued, should not invest in tobacco, alcohol or weapons stocks. Union pension plans may not want to invest in companies with questionable human resource practices or that discourage unions.
Professionals know that performance is period-sensitive, so it is no surprise that a survey of the academic literature about ESG and responsible investing performance by Advisor Perspectives was inconclusive. Examples of underperformance are balanced by those showing outperformance.
Long-term investors buy stocks to participate in the growth of an economy so funds and ETFs will be available to do this with specific exclusions and inclusions. Over time I expect performance will converge and individual ESG preferences will matter less. One exception is if growing concern over the unfettered power, gender and privacy issues of technology giants like Facebook and Google leads to broad tech-sector exclusions: technology represents a large part of the market, so tracking error would increase.
ESG choice for clients
Six years ago I recommended advisors make ESG investing available to clients like a vegetarian offering on a steakhouse menu. Only the iShares Jantzi Social Index existed, so using long-short tactics was required to isolate issues; otherwise investors had to buy portfolios of individual securities. Today there are 18 ESG ETFs trading in Canada and more than 250 mutual funds—more if you include government bonds. With choice comes confusion.
Does a client prefer to take the traditional approach and exclude things like tobacco, alcohol, marijuana, firearms, military weapons and carbon-based energy? Or is it better to include actionable impact themes for positive exposures? One way to organize priorities is to focus on themes. Chart 1, derived from MSCI ESG Research and the U.N. Sustainable Development Goals, shows objectives divided into five themes. My preference is to focus on basic needs, as the Bill and Melinda Gates Foundation does, because that produces the most positive impact per dollar invested.
Chart 1: Multiple goals organized into seven actionable impact themes
Less attractive to me is investing in climate change initiatives that, despite an obvious need, can’t make a meaningful, cost-effective, long-term impact on CO2 emissions given existing technology. Your clients may feel differently. The list of ESG ETFs trading in Canada in Table 2 is derived from public information and shows my interpretation of the key impact theme(s) for each. Multiple categories indicate broader scope.
|Ticker||Mgt. fees||Basic Needs||Empowerment||Natural Capital||Climate Change||Governance|
|Desjardins RI Active Canadian Bond||DRCU||0.35%||✔|
|iShares Jantzi Social Index||XEN||0.50%||✔||✔||✔||✔||✔|
|Desjardins RI Canada Low CO2||DRMC||0.25%||✔|
|Desjardins RI Canada Multifactor Low CO2||DRFC||0.50%||✔|
|iShares ESG MSCI Canada Index||XESG||0.20%||✔||✔||✔||✔||✔|
|Desjardins RI USA Low CO2||DRFC||0.50%||✔|
|Desjardins RI USA Multifactor Low CO2||DRFU||0.50%||✔|
|iShares ESG MSCI USA index||XSUS||0.25%||✔||✔||✔||✔||✔|
|Desjardins RI Developed ex-USA ex-Canada Low CO2||DRFD||0.60%||✔|
|iShares ESG MSCI EAFE index||XSEA||0.30%||✔||✔||✔||✔||✔|
|AGF Enhanced ESG Global Factors||QEF||0.45%||✔||✔||✔||✔||✔|
|Desjardins RI Global Mulfifactor Fossil Fuel Reserves Free||DRFG||0.60%||✔|
|Horizons Global Sustainability Leaders||ETHI||0.65%||✔||✔||✔||✔||✔|
|MacKenzie Global Leadership Impact||MWMN||0.65%||✔|
|Desjardins RI Emerging Markets Multifactor Low CO2||DREF||0.65%||✔|
|iShares ESG MSCI Emerging Markets Index||XSEM||0.35%||✔||✔||✔||✔||✔|
|RBC Vision Women’s Leadership MSCI Canada||RLDR||0.25%||✔|
|Evolve North American Gender Diversity Index||HERS||0.40%||✔|
Source: PŮR Investing Inc.
Conclusion: Measure things
People are naturally competitive. Measuring things leads to comparison and comparison can lead to action. An example is medical service wait times that have become a benchmark for Canada’s healthcare system as established in 1990 by the Fraser Institute. Measuring outcomes would be more valuable, but wait times impact everyone.
So it may be with environmental, social and governance issues. Measure something. If the goal is diverse thinking, injecting women into the conversation may be useful. Percentage of women on boards or at executive levels is an easy number to monitor and a good metric, but doesn’t ensure diverse thinking. Investor, consumer and portfolio manager scrutiny, oversight and direction are still needed to police desired values.
Reich says that getting companies to make commitments to good social behaviour relieves politicians from implementing legislative changes. Companies, on the other hand, count partly on mitigating legal constraints by engaging in some of these ESG initiatives. That’s just good business. Self-interest or impact? Sometimes goals are advanced when one serves the other.
Disclosure: Mark Yamada’s spouse is on the advisory committee of the 30% Club, whose goal is to increase gender diversity in corporate Canada.
Mark Yamada is president of PÜR Investing Inc., a software development firm.