What does the sustainable investor buy: a better world? Or a good night’s sleep?
Sustainable finance is “hot” – but “doing it right” turns out to be more complex in practice than it seems. In this column, DSI invites professionals to share their views on the tensions, dilemmas and unwritten rules in sustainable finance. Every month we publish a new guest column, inspired by the dialogue document Between the Rules. What do you notice? What is chafing in practice? And what is needed for real sustainability in the sector?
By Harald Walkate
Sustainable investing has taken off in recent years. That’s good news, you might think; apparently savers, investors and pension fund beneficiaries want to contribute to a better world.
But it also raises the question of what sustainable investing really achieves. Many investors might expect the money from sustainable funds to flow directly to the companies that are doing good things for people and planet, and their capital to enable those companies to do even more good. “Additionality” is the jargon term for this: investments allow things to happen that wouldn’t otherwise happen. In other words, there is a causal relationship between the investment and a better world.
The promise of sustainable investing
The reality is less straightforward, however, for several reasons. (1) Most sustainable funds invest primarily in publicly traded companies, where the money flows not to the companies but to the sellers of the shares. (2) Many solutions to sustainability-related problems cannot (yet) be deployed on a commercial basis, so publicly traded companies – whose primary goal is profit – cannot provide these solutions. (3) Many sustainability challenges are “systemic” in nature; in other words, the solution to these challenges is not simply the summing up of all consumers and businesses doing things a bit more sustainably – “systemic” incentives are needed to discourage certain behaviors and encourage other behaviors. And who can create these incentives, you might ask? Yes, that’s right, governments.
So are sustainable funds a new mis-selling scandal in the making – where promises are made that cannot be kept, and at great cost to the consumer? Not necessarily. Because this depends entirely on the expectations of the consumers who allocate money to a sustainable fund.
What really drives the sustainable investor?
Roughly speaking, there can be three motivations for sustainable investing:
(a) A good night’s sleep: “I don’t want to invest in ‘bad’ companies: tobacco, weapons, fossil fuels – I understand that this won’t reduce the number of cigarettes smoked or wars fought, and I understand my financial returns may be a little lower, but I don’t want to profit from these activities.”
(b) Return: “I believe I can generate better financial returns by investing in companies that score well on sustainability.”
(c) Additionality: “I invest because my money enables sustainability solutions that would otherwise not be possible – my money contributes to a better world.”
Can these wishes be granted? A very simplistic answer to this question, based on academic research, is: (a) yes, very well; (b) no; (c) to a very limited extent.
And what do we actually know about what truly motivates consumers? Very little, unfortunately; although this is an important question it has hardly been studied by academics, nor is it a topic that financial institutions regularly discuss with their customers.
And this is why DSI’s “Between the Lines” initiative is so important and why the title of the discussion paper is so well-chosen: to determine if the consumer is getting what they are buying, we must first establish what the consumer thinks they are buying – is it (a), (b) or is it (c)? In other words, the financial institution must read between the lines; it isn’t enough to establish that the consumer wants to “invest sustainably” – it must establish what consumers think they are getting in doing so.
And what makes the title even catchier is that there are already all sorts of rules around sustainability that financial institutions must comply with; for example, the European Sustainable Finance Disclosure Regulation (SFDR) that requires classification of funds according to their sustainability approach. Financial institutions are literally surrounded by rules.
Why clear expectations are crucial for real impact
But these rules and classifications can tell us very little about the extent to which funds align with motivations (a), (b) or (c). Financial institutions should know this, and therefore there’s all the more reason to carefully examine what consumers think they are buying: a higher return? A good night’s sleep? Or … a better world?
Good to see DSI raising the “Between the Lines” discussion; after all, if put to the right use, our savings can make a big contribution to solving societal problems, but this does require an honest conversation about what exactly motivates investors, what the trade-offs of specific investments are, and when and where money can really make a difference.
