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Doing good while doing well: Fact, fiction, or an aspiration?

If investing in only good firms — firms that pay their employees properly, do not pollute, have a strong number of women and minorities in leadership positions, et cetera et cetera — made people richer, then the world would be a much better place. Yet despite so many calls for people to change their consumption behaviors — stop plastic use or avoid fast fashion, buy fair trade or organic, boycott this or that company, shift to renewable energy — the fact is that people have yet to completely dedicate themselves to a life of being truly responsible for their actions, whether direct or indirect, because there seems to be no extrinsic benefit; or if there is, it is negligible. And knowing consumers’ behaviors, investors are wary about putting all their money in good firms since that’s not what sells. Our society has become so framed in capitalism that it is difficult to not require what we in business schools term exactly that: a business case. “Tell me why I should invest in good firms,” is another way of saying: “I know this company is nice and all that, but will it make me money?”

As such, asset managers actually asking what should be urgent and obvious questions when they probe a company’s environmental, social, and governance practices, are often seen as controversial. The practice of asset management is a widely acceptable means of investing current wealth in anticipation of higher expected future returns. The idea behind asset management is that it is more effective and less risky to pool money — “assets” — from several individuals or organizations and to outsource the collective management of these assets to a specialized firm. This allows risks to be spread across a diversified portfolio of assets, which would otherwise be more expensive to do individually due to high transaction costs. The onus is that an efficient portfolio can only be created through specific combinations of risk and return. The investor would (or should) then want to select one of those portfolios which give rise to the efficient combinations of the two. This theory — Markowitz’s Modern Portfolio Theory — is arguably the most strongly manifested theoretical underpinning in the practice of asset management. Highly sophisticated tools are available for asset managers to use to create an efficient portfolio and the performance of a fund is judged on whether it is able to achieve a return above a previously identified benchmark (usually a market index such as the S&P 500 in the US, the MSCI Index in Europe, or the PSEi in the Philippines).

Traditional asset managers are tasked to make money for their investors. They are not hired to make moral or ethical choices. Engaging in responsible investment — even if it sounds nice on paper — still gets eye rolls in the industry; because by accepting Responsible Investment as Mainstream, the very core theory of Finance, that of Risk Diversification, gets threatened. Another issue is the time horizon of markets. By selecting assets based on sustainability issues of a longer-term nature, one might be missing out on opportunities in the short run.

The bottleneck ultimately lies in financial persons and particularly asset managers still “looking at sustainability with a financial lens,” but that is the archetype we must work with and elaborate if we are to make any changes. If they care about risk and return, well then we must introduce new sources of risk and return.

And here is the best pitch of that so far: Responsible Investing (RI) has risk-reducing benefits which appear as a by-product of the information depth and reputational benefits that occur because of probing deeper into the sustainability practices of a firm. Proponents posit that by having more information, they can make better decisions and select more stable and predictable firms that will survive the test of time and be able to address the complex problems our world faces. In my research work on European equity RI mutual funds, I found empirical evidence to show that while limiting the investable universe increases idiosyncratic (specific) risk due to portfolio diversification issues, engaging in substantive RI can be risk-reducing since informational benefits allow fund managers to be more selective.

So maybe in the short-term, one will make money by investing in the firm that outsources the cheapest labor using the most polluting form of low-quality production by sheer amount of volume and margins. But in the long term? We know that such firms will not withstand the test of time. There will be cracks in their leadership, cover-ups that regulators will find out about, and a market audience that will be increasingly educated and agile with information now commoditized from digital and social media outlets that will make them short-lived in a future filled with people who have begun to question the status quo. Doing good while doing well: Fact, fiction, or an aspiration? Neither of the three. Looking beyond financial theories and into the horizon, it is investors’ only remaining choice.

 

Daniela “Danie” Laurel is a business journalist and anchor-producer of BusinessWorld Live on One News, formerly Bloomberg TV Philippines. Prior to this, she was a permanent professor of Finance at IESEG School of Management in Paris and maintains teaching affiliations at IESEG and the Ateneo School of Government. She has also worked as an investment banker in The Netherlands. Ms. Laurel holds a Ph.D. in Management Engineering with concentrations in Finance and Accounting from the Politecnico di Milano in Italy and an MBA from the Universidad Carlos III de Madrid.

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