Do portfolio managers care about society?

Dr Tom Gosling, Head of Finance, London Business School

A recent study co-authored by Alex Edmans (London Business School), Dirk Jenter (London School of Economics) and myself asked over 500 portfolio managers how they factor environmental and social (ES) performance into their investment decisions. ; We wanted to hear the views of the people who actually manage the money every day, not the opinions of their accountability teams.

We focused on how investors think about ES performance of the companies they invest in, unlike in ES risks, so, for example, the carbon dioxide emissions of a real estate company, instead of the risks caused by sea level rise facing their portfolio. Of course, a portfolio manager may care about ES performance because it leads to ES risk – higher CO2 emissions could lead to higher costs in the future if a carbon tax is imposed. But ES performance affects society.

Portfolio managers were either “sustainable investors” (who managed a fund marketed as sustainable, ESG or similar) or “traditional investors” (whose funds had no such marketing). The findings are nuanced and do not support either extreme of the ESG debate.

For ESG skeptics

Portfolio managers rate ES performance as least important on a list of six factors that influence value creation in the companies they invest in. It ranked well below governance (which is often lumped together with ESG to form ESG) and even below capital structure, which in an idealized world should have little impact on company value. This applied to sustainable investors and traditional investors.

Not surprisingly, we have also found that investors seek to maximize returns. Only 23% of investors would sacrifice even 1 basis point of yield in exchange for ES outperformance, and only 27% had ever voted on a shareholder resolution that was even slightly negative in terms of shareholder value. The differences between sustainable and traditional investors were small. They feel that their fiduciary duty simply does not allow it. At the same time, investors think that companies are already generally investing in ES performance at about the right level to optimize shareholder value, so they seem to have little incentive to ask companies to do more.

For ESG supporters

But even though ES is relatively insignificant, 85% of investors, including 78% of sustainable investors, consider at least one dimension of ES performance to be relevant. absolute terms. Not surprisingly, the dimensions most closely associated with value, such as employees and consumers, receive the highest scores. But many investors also consider other environmental and social issues relevant.

73% of sustainable investors and 45% of traditional investors expect good ES performers to generate higher total shareholder returns, which is surprising given that no such consistent link is found in academic research. The most popular explanation is not that ES performance is directly beneficial to firms per se, but that ES performance is correlated with other factors that increase returns. For example, a company that takes care of its ES business is likely to be a well-run company overall.

A good ES performance is considered particularly important to protect against downside risk: 67% of traditional and 61% of sustainable investors believe that poor ES performers will produce worse returns.

Mandates versus beliefs

What determines whether investors consider the ES performance of the companies they invest in?

We identify two channels.

One of them is restrictions such as authorizations and company-wide policies that limit the freedom of investors. 85% of sustainable investors have changed their behavior due to such constraints, and in about half or more of these cases, this has resulted in lower returns.

Another channel is investors’ beliefs. Investors who believe good ES performance leads to better stock price performance are more likely to factor it into the investment process: 73% allocate stocks based on ES performance to increase returns or reduce risk, and 87% to engage with companies to improve ES performance.

Given the constraints (mandates, company-wide policies, etc.) and especially beliefs that don’t divide neatly between traditional and sustainable lines, investors choosing a fund manager need to look under the hood to understand what type of ES income they’re actually getting. instead of just relying on the label.

What can we conclude as a whole?

The efficiency of ES matters to investors, but it is not the main driver of value.

We cannot expect investors to lead to the solution of society’s problems. But despite the ESG backlash, most portfolio managers, whether traditional or sustainable, continue to factor ES performance into stock selection and allocation where they believe it is financially relevant.

Dr Tom Gosling is an Executive Fellow in the Department of Finance at London Business School, where he promotes evidence-based responsible business practice through the integration of academic research, public policy and business. He is also an inaugural member of the European Corporate Governance Institute and a member of the Financial Conduct Authority’s ESG Advisory Board. He is on the Financial Reporting Council’s Advisory Panel and Stakeholder Insights Group.