This is the second installment in a new series we launched last month that highlights opportunities for taking a third side approach to difficult decisions about the most pressing issues of the day. Our hope is to provide support for navigating disagreement in a constructive, principled way during this period of heightened conflict. (To see what we mean by the Third Side, please see our Guiding Principles here.)
This month, we will focus on a question that has been getting renewed attention in the news this month: Is sustainability a systemic risk that requires integration in investment decision-making, or a “nice to have” that is failing to deliver real results?
1. The Skeptical View: Sustainability as “Nice to Have”
For some, sustainable investing has failed to live up to its early promise. In Institutional Investor, the authors summarize the criticisms:
- Sustainable investing has often been more hype than substance: “Sustainable investing doesn’t work. ESG is just marketing. Impact investing is a club. … those criticisms are … partly true.”
- Trillions of dollars have flowed into ESG products, but results have been uneven: “The successes are good businesses. The others generally fail because … socially responsible investors did not consider the fundamentals of good investing.”
- Heavy reliance on ESG ratings has compounded the problem: “Upgrades or downgrades in ESG ratings actually show an inconsistent correlation with stock performance.”
Takeaway: Some view sustainable investing as a marketing ploy rather than a substantive tool in reducing risk, increasing performance, and delivering impact on sustainability, and others feel it is just an unhelpful distraction from the issues on which corporate managers and investors should be focusing.
2. The Strategic View: Sustainability Is a Systemic Risk
At the same time, the authors argue that dismissing sustainability as irrelevant to systemic risk is shortsighted.
Externalities like climate change are material: “Climate change is fundamentally an economic challenge, with most … externalities not being priced into decision making of policy makers or investors.”
- Global trends amplify the risk: “Mega-trends like climate change and artificial intelligence … will fundamentally reshape the global economy.”
Long-term valuation hinges on sustainability: “The terminal value of a company … [is] deeply influenced by how a company manages its intangible assets and its externalities.”
Takeaway: Ignoring sustainability creates exposure to regulatory, reputational, and valuation shocks that can erode long-term value.
3. The Third Side: Don’t Abandon, Get More Specific
The way forward, the article argues, is not to abandon sustainability but to sharpen it.
Clarify purpose: “It is the lack of clarity around purpose which has confused the messaging and implementation of the idea from the get-go.”
- Focus on fundamentals: “Sustainable investing strategies should be defined by an unwavering focus on valuing the long-term earnings trajectory … by assessing … planetary and social impacts.”
Get Specific: “In practice, discussions related to assessing and responding to climate change risk have conflated categories of risk, confusing discussions and undermining the effectiveness of related strategies,” as outlined in Distinguishing among climate change-related risks.
Takeaway: Much of the skepticism about whether sustainability is a material systemic risk that both ought to be integrated into investors’ analyses and is something that investment can help solve, comes from the fact that the term “sustainable investing” is broad and vague. Instead of abandoning the integration of sustainability into management and investments decisions, the third side approach recognizes that effectively addressing sustainability as a systemic risk requires getting more specific. What exactly are the concerns? How will you address them?
An important next step is to move away from broad ESG “labels” to a more granular and concrete integration of sustainability into risk, valuation, and strategy for each company based on the specifics of their industry, geography, customer and employee base.
Our new tool, Principled Influence: A Guide to Strengthening Public Affairs Practices in Polarized Environments, can help support you to perform that more context-specific analysis.
Share Your Thoughts
This stuff isn’t easy. The more we talk and share best practices, the better we all will get at finding new ways to the third side, especially during these challenging times.
Let us know what you think: please share your thoughts.