Alex Edmans, Professor of Finance at London Business School, is speaking at the Institutional Fixed Income Summit on November 24. To find out more about the conference, or to book your place, click here.

Sara Benwell: Why should responsible investment matter to non-ESG investors?

Alex Edmans:  This is because responsible investment can improve financial returns. Responsible investment is considering ESG factors in investment decisions, so it is broadening the amount of information that we are going to be using to decide which companies to invest in and which to avoid.

The interesting thing with ESG information is that it is often missed by the market. Traditionally, investors might have looked at factors like profits and dividends but everyone else notices that and so it is likely to be priced in. With ESG factors, there is the view that it is only relevant to ESG people therefore mainstream investors may ignore it and so it might be mispriced by the market.

“Responsible investment can improve financial returns”

One of my papers found that companies who treat their employees well, as measured by their inclusion in the best companies to work for, beat their peers by 2.3-3.8% over a 28-year period. That is 89-184% compounded in terms of total shareholder returns.

Interestingly, whilst my paper was published in 2011, it has since been replicated for the last 10 years and the results continue to hold, so investors are still not taking this information into account.

Sara Benwell: Do non-ESG investors have sufficient knowledge and data to make strategic responsible investment decisions?

Alex: Unfortunately not, and part of this is claims by the ESG industry which are incorrect. There are many ESG advocates who make strong claims such as that ESG always pays off, when, in fact it doesn’t. Only some ESG dimensions do but others don’t. Therefore, why some investors may not have sufficient knowledge is that they may view some ESG dimensions as relevant when they are not.

For instance, there is a view that the higher the pay ratio between the CEO and the workers, the worse the performance because high pay ratios are demotivating. Indeed, a few years ago I was testifying in the house of commons in their enquiry into corporate governance and the witness before me made this exact claim.

“There are many ESG advocates who make strong claims such as that ESG always pays off, when, in fact it doesn’t”

The witness referred to a paper which was a half-finished paper, the finished version of this paper was actually published before the enquiry, and it showed a completely opposite result. Once it went through peer review and corrected all of its mistakes, it actually found that high pay ratios were connected to better company performance.

The problem is that because people don’t like this idea, they like to believe that inequality is a bad thing and so they have just latched onto the first, half-finished study, even though it was only half finished. Disappointingly the House of Commons final report referred to this half-finished study.

Sara: Should ESG investment still be its own investment style – or should we be moving to an approach where all investment is responsible?

Alex:  I feel that ESG investing should not be its own investment style, but it is just investment. There isn’t anything specifically responsible about ESG investment, it is a set of factors which might be linked to long-term, superior returns. Any investor should want to use information which is value relevant.

To the extent to which ESG investment still seems to be responsible or sustainable and therefore niche and not mainstream then people aren’t going to be taking it into account. One of the goals of my work and research is to try and make ESG mainstream and therefore not be seen as its own investment style.

Sara: For institutional investors thinking about responsible investment, what are some of the main things they should be considering?

Alex: They should be looking very carefully at the data to see what are the ESG factors that are linked to superior returns, and which are not. Again, this is an area where there is a lot of misunderstandings with many claims that ESG always pays off.

Due to confirmation bias these claims are accepted uncritically as people would like to believe that ESG always works and so any study that is claiming that is going to be liked and shared but it isn’t the case.

One of the reasons why I wrote my book grow the pie, how great companies deliver both purpose and profit, is to lay out the evidence of what works and what does not in a clear and simple way which is accessible to all and not just to academics.

Alex Edmans, Professor of Finance at London Business School, is speaking at the Institutional Fixed Income Summit on November 24. To find out more about the conference, or to book your place, click here.

 

 

 

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