However, 10X’s argument is based on a mischaracterisation of sustainable and responsible investing. It sets up various straw men and ignores recent evidence that contradicts it argument. The reality is not as clear cut as is presented, and some of the underlying reasoning appears to be clouded by 10X’s vested interest in the debate between active and passive investment management.
Sustainable investing not just “negative screening”
High ESG ratings correlated to market-based outperformance
While evidence from South Africa showing that sustainable investing can yield superior investment returns might be lacking, various international studies have shown that outperformance can be achieved. In June 2012, Deutsche Bank published a report which found that 89% of the 100 academic studies, 56 research papers, 2 literature reviews and 4 meta studies it considered showed that companies with high ESG ratings saw market-based outperformance. The report also found strong evidence that companies with high ESG ratings have a lower cost of capital, which effectively means they are lower risk.
With respect to negative screening based on ESG factors, Deutsche Bank found that this strategy showed “little upside, although it does not underperform either”. Many investors might be readily prepared to accept this trade-off, especially if it allows them to benefit from other non-financial objectives such as the alternative tangible upside of knowing you’ve done some social good, or the important behavioural upside of feeling more comfortable with the portfolio. If this provides investors who would otherwise sit on the sidelines with the confidence to invest, the overall effect on their total wealth could even be significantly positive despite the trade-off at the level of specific investments. Over the long term it is much better to be in a slightly inefficient investment than not invested at all (even before counting the added social returns).
Mainstream investment analysis is also subjective
In the eye of the beholder
While the assessment of compliance might be based on past behaviour, it can offer insight into corporate behaviours such as risk appetite and can be an indicator of management quality. When the “beholders” include regulators that can levy fines, institute legal action or, as happened in ArcelorMittal’s case, issue instructions to cease operations for non-compliance, investors should pay attention. Failure to do so can be catastrophic. In the 3 years prior to the Deepwater Horizon blowout, the US Occupation Safety and Health Administration issued 760 Egregious Wilful Citations, , 97% of the total number, for safety violations at BP’s five US refineries.
SRI is not, as 10X alleged, only about social good. It is also about assessing risk and opportunities. It takes the concerns of other stakeholders, not just shareholders, into account, as it understands that this is necessary in order to act in the best interests of pension holders. One only has to look at the current issues in South Africa’s mining sector to understand that employees, communities and the environment are integral to the long-term sustainability of these companies. It is not SRI that fails to serve retirement investors’ interests, but the failure to adequately consider material ESG factors that affect the long-term sustainability of investments.