Blog Post

The rise of ‘ethical’ investing

We are used to think about the value of investment as measured by financial return. But investing with an eye to environmental or social issues and, more generally, ethical considerations, has become more prominent. We review contributions to this debate.

By: Date: October 29, 2018 Topic: Finance & Financial Regulation

Environmental, social and governance (ESG), socially responsible investing (SRI), impact investing and gender-lens investing have emerged as a response to investors’ will to combine ethical with financial considerations in investment decisions (see here for an explanation of the differences).

The US Forum for Sustainable and Responsible Investment is due to publish its latest biannual report on US sustainable, responsible and impact investing trends on October 31st. The previous report, out in 2016, revealed a 33% increase in sustainable investing assets since 2014. This week, BlackRock announced that it will launch a line-up of sustainable exchange-traded funds (ETFs) that will allow investors “to align their investments with their values and long-term financial objectives”. BlackRock stated that according to its projections, ESG ETF assets are expected to grow from $25 billion today to more than $ 400 billion by 2028, which could result in an increase in the ETF share of total ESG ETF and mutual fund assets from 3% today to 21% by 2028.

Colby Smith at FT Alphaville thinks that BlackRock’s optimism is premature and cites an analysis by Renaissance Capital, according to which the relationship between ESG scores and financial performance is weak at best and non-existent at worst. Renaissance Capital’s Charles Robertson – cited in the Alphaville piece – argues that while “we would love to think that investing in line with ESG principles would both feel good and show up in market pricing”, there is “virtually zero correlation between sovereign bond pricing (using credit default swaps) and ESG scores (obviously after adjusting for per capita GDP) and not much in the equity markets either. Indeed, the best-performing DMs and EMs in 2018 have the worst ESG scores.”

Sara Bernow, Bryce Klempner, and Clarisse Magnin at McKinsey argue that some institutional investors have held back, and one common reason is that they believe sustainable investing ordinarily produces lower returns than conventional strategies. The authors’ interviews with investors, however, reveal that enhancing returns is a factor in why they pursue sustainable investments.

The evidence is mixed. Several studies have shown that sustainable investing and superior investment returns are positively correlated. Other studies have shown no correlation. Recent comprehensive research (based on more than 2,000 studies over the last four decades) demonstrates sustainable investing is uncorrelated with poor returns. For many investors, the likelihood that sustainable investing produces market-rate returns as effectively as other investment approaches has provided convincing grounds to pursue sustainable investment strategies – particularly in light of their positive effects on risk management.

Back in April, a joint report by the World Bank Group and Japan’s Government Pension Investment Fund (GPIF) found that investors are increasingly combining ESG and impact considerations, e.g. by measuring the impact of their fixed income and other portfolios on targeted ESG outcomes or more broadly against the Sustainable Development Goals (SDGs). Despite this positive trend, however, significant constraints limit the wider adoption of ESG considerations in fixed income markets. There are no standard definitions of ESG; data is still wanting particularly in emerging markets and there are additional issues, such as the role ESG plays in credit ratings and the lack of ESG-focused products for fixed income investors.

The report recommended promoting more robust research on the impact of ESG factors on fixed income investment; refining principles and metrics to allow for customised approaches by investors; and developing innovative products to accommodate the growing demand for fixed income sustainable investments, as the call for green and other labeled bonds currently outstrips supply.

The Economist similarly argues that this nascent investing space still suffers from definitional quibbles: both over where to draw the line between sustainable and “normal” investments, and how to subdivide the universe of sustainable investment. For example, the Global Sustainable Investment Alliance (GSIA) – an umbrella group –  counts seven distinct strategies. As demand has broadened, mainstream financial firms have entered the space, but consistent measures and ratings are still a work in progress, as are measures that allow for comparison across investments.

The fundamental question is the trickiest to solve, because it boils down to ethics rather than finance: how can the relative value of, say, educating a girl in the developing world be compared with preventing a tonne of air pollution? In the end, investors’ choices among the different variants of sustainable investments will be driven by their own personal interests, rather than just by financial calculations.

Regulators are responding to these shortcomings. In April, the US Department of Labor released guidance aiming to clarify the administration’s view about how plan sponsors should consider ESG factors when selecting retirement plan investments (see here for a discussion). In Europe, the European Commission issued a proposal in May aimed at making it easier and less costly for investors to identify which investments are sustainable. Andy Pettit at Morningstar says that the difference between the European and US approaches to sustainable investments is stark. The Commission’s proposals are heading down a path of enabling ESG factors to be the primary driver of investment selection if an investor wishes so. As such, they go much further than the US Department of Labor’s guidance, in which plan fiduciaries can use collateral considerations such as social or environmental benefits as tie-breakers for an investment choice.

EIOPA’s Occupational Pension Stakeholder Group, while agreeing with the Commission on the importance of adopting a taxonomy as an enabler for integrating ESG factors in investment decisions, argues that prudential frameworks should remain risk-based. ESG investments will often be long-term and there are concerns that some of the existing prudential rules need improving to better reflect the true risks of such long-term investments.

While some argue that ESG risks are sufficiently material to include them in prudential frameworks, there is a risk that politicians wish to achieve political objectives by tweaking risk weights or capital charges. As investors in the banking and insurance sectors, pension funds want to see strong evidence of ‘green’ support or ‘brown’ penalising factors contributing to financial stability before such measures should be adopted.

Similarly, policymakers should be very careful before making the use of the taxonomy mandatory as a risk-management tool. However carefully designed, it is not inconceivable that the taxonomy will over- or understate some types of ESG risks. An overly strong and harmonised dependency on the taxonomy could then lead to green bubbles.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 20, 2019
Read article More by this author

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Energy & Climate, Innovation & Competition Policy Date: May 13, 2019
Read article More on this topic More by this author

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: May 6, 2019
Read about event More on this topic

Past Event

Past Event

Principles of sustainable finance

How can finance help save the planet?

Speakers: Rebecca Christie, Pascal Coret, Mario Nava and Dirk Schoenmaker Topic: Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: April 30, 2019
Read article Download PDF More by this author

Parliamentary Testimony

Promoting sustainable and inclusive growth and convergence in the European Union

This speech was delivered by Guntram Wolff at the Informal ECOFIN Meeting in Bucharest on 5 April 2019.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance, Testimonies Date: April 8, 2019
Read article More on this topic More by this author

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midoes Topic: European Macroeconomics & Governance Date: April 8, 2019
Read article Download PDF

Policy Contribution

Promoting sustainable and inclusive growth and convergence in the European Union

This Policy Contribution was written for the Informal ECOFIN Meeting, Bucharest, 5 April 2019. The authors look at the EU’s economic agenda, discussing the priorities for the next five years.

By: Maria Demertzis, André Sapir and Guntram B. Wolff Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: April 4, 2019
Read article More on this topic More by this author

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: April 1, 2019
Read article More on this topic More by this author

Blog Post

The shadow of Brexit: Guessing the economic damage to the UK

Under a set of assumptions, this post concludes that UK real income and investment would have been 4% and 6% larger respectively had it not been for the shock of the Brexit referendum result. With somewhat audacious assumptions, the damages already incurred can be scaled up to guess the negative macroeconomic consequence of each of the three possible Brexit outcomes: no-deal, deal or no Brexit.

By: Francesco Papadia Topic: European Macroeconomics & Governance Date: March 21, 2019
Read article Download PDF More by this author

Working Paper

Greening monetary policy

The author proposes a tilting approach to steer the allocation of the Eurosystem’s assets and collateral towards low-carbon sectors, which would reduce the cost of capital for these sectors relative to high-carbon sectors. Central banks have already started to look at climate-related risks in the context of financial stability. Should they also take the carbon intensity of assets into account in the context of monetary policy?

By: Dirk Schoenmaker Topic: Energy & Climate, European Macroeconomics & Governance Date: February 19, 2019
Read article More on this topic More by this author

Blog Post

On Modern Monetary Theory

An old debate is back with a kick. The discussion around modern monetary theory first gained traction in the economic blogosphere around 2012. Recent interventions in the US and UK political arenas rekindled the interest in the heterodox theory that is now seeping into mainstream debates.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: February 11, 2019
Read article More on this topic More by this author

Blog Post

The American tax debate

The debate over two different proposals for tax reforms: Senator Elizabeth Warren’s plan for a tax on wealth, and Congresswoman Alexandria Ocasio-Cortez’s plan for a higher top marginal tax rate on income

By: Enrico Bergamini Topic: Global Economics & Governance Date: February 4, 2019
Load more posts