In The ESG Investing World, The Customer Isn’t Always Right, & Wall Street Is Too Often Wrong  

Being a socially responsible investor

by James Katz

One of the dominant approaches to building environmental, social and governance (ESG) portfolios on Wall Street today is to entice people to invest with their gut, to pick which societal issues they care about like climate change or corporate board diversity, and then tailor the portfolio to those stated preferences. This “choose your own values” approach has an attractive logic: ESG can be a murky and contentious topic that people disagree on, so why not let everyone make up their own minds about it? It seems to make sense. But underneath the veneer of customization lies a dark truth – socially responsible investors, who usually come to invest with good intentions, are not always best positioned to pick which societal issues they should care about. So, when investment managers encourage investors to make this choice on their own, they could be doing them a huge disservice.

For example, an investor might know in their gut that war is evil because it leads to so many people’s deaths all over the world, and they therefore want to make sure that none of their investments are involved in it. Let’s say they do some research online and find a fund offered by a large traditional asset manager that excludes companies involved in making weapons. The client invests happily and moves on with their day. There is so much that seems right about this story, but under the surface there is something very, very wrong. The investor may think that they’ve done their duty to invest in a way that isn’t hurting people, given how they went out of their way to exclude weapons companies from their portfolio. War is responsible for tens of thousands of deaths globally every year. But ambient air pollution kills about four million people each year and yet the investor didn’t take that into account when they invested.

There is another big problem with pushing people to invest with their guts. Research by Nobel-prize winning psychologist has shown that we tend to care more about negative things as compared to positive things – losing $20 can feel about twice as bad as the good feeling we get from winning $20. So when it comes to socially responsible investing, clients may tend to worry much more about the bad things that a company does and consider the positives less. But in reality, the positives are just as important. Companies provide profits for investors of course, but also jobs for employees that help them survive, and products for customers that can be very beneficial. If a company produces a new medication that saves millions of people’s lives, that is obviously commendable. If you want to avoid killing people when you invest by considering issues like war, the logical extension of that is to seek out and invest in companies that promote life, like companies that provide access to healthcare, food, or clean water.

The Solution

There is a solution to these problems – socially responsible asset managers must take the time to research every possible issue so that they can understand the relative importance of each issue and its impact on humanity before they try to pick the right mix of themes for their products. For advisors and investors, picking the right manager can be tricky, but looking for a disciplined investment manager that is exclusively focused on socially responsible investing is probably a good first step.

If you’re a socially responsible investor, your gut isn’t all bad – it led you to want to invest in a way that will be good not only for you, but also for humanity. But when it comes to the details of how to turn that dream into a reality, it’s critical to have someone roll up their sleeves and take the time to dig into the nitty gritty research on as many issues as they can find.

Beware investment firms that offer one or two, or even a handful of themes that happen to be popular today, or for whom social responsibility is just one of many flavors of investing. A true socially responsible investor needs to try and take a broader view of how their investments impact humanity across every possible issue. Meanwhile, investment firms should be authentic and systematic in how they pursue the goal of investing in a way that minimizes human suffering while maximizing human benefit.

References:
-Uppsala Conflict Data Program (2018). Retrieved from https://ucdp.uu.se/
-World Health Organization (2016) Ambient Air Pollution Attributable Deaths. Retrieved from: https://www.who.int/data/gho/data/indicators/indicator-details/GHO/ambient-air-pollution-attributable-deaths on June 21, 2021.
– Kahneman, D., & Tversky, A. (2013). Choices, values, and frames. In Handbook of the fundamentals of financial decision making: Part I (pp. 269-278).
-Tversky, A., & Kahneman, D. (1991). Loss aversion in riskless choice: A reference-dependent model. The quarterly journal of economics, 106(4), 1039-1061.