Bridge over ocean
1 September 2015 CFA Institute Journal Review

Sustainable Development and Financial Markets: Old Paths and New Avenues (Digest Summary)

  1. Butt Man-Kit, CFA

Although financial market participants are increasingly integrating environmental, social, and governance factors into their investment decisions, no real shift toward more sustainable business practices seems to be happening. The authors identify the new avenues of sustainable investments that may help in changing this situation.

What’s Inside?

In recent years, sustainable investment practices have been increasing at a fast pace. Paradoxically, global resource consumption and carbon dioxide emissions are still growing, which raises the question of whether this growth implies that sustainable investments are in fact a myth. The authors find that investors who integrate environmental, social, and governance (ESG) factors are still mainly motivated by short-term rather than long-term benefits, which does not seem to be sufficient for sustainable investments to spur sustainable development. They propose a methodological redirection of sustainable investments toward a long-term paradigm.

How Is This Research Useful to Practitioners?

The objective of this research is to find ways to transform sustainable investments into sustainable business practices. With respect to the relationship between corporate social and environmental performance and financial performance, one common conclusion is that there is no clear indication of a negative relationship between them. Thus, it is possible to have a win–win scenario in which a high financial return is achievable by investing in good ESG companies, leading to companies increasing their sustainable business practices. But the emphasis of sustainable investments often remains in the short term and does not allow for the promotion of long-term sustainable business practices. The authors propose two ways to overcome the problem.

First, a reorientation toward a long-term paradigm for sustainable investments is important. Investors should incorporate long-term global trends, such as the negative externalities of climate change on ecological and human social systems, into their business strategy. Ignoring the long-term externalities may put certain businesses at risk in the future. Nowadays, investors may have difficulties in pricing ESG-relevant information, but in the long run, investors should be able to learn how to price it. Therefore, the authors suggest investing in companies that are performing poorly in ESG factors and encouraging them to improve their ESG scores. If successful, other market participants should recognize it in the future and stock returns should rise.

Second, ESG data must become more trustworthy. A shift toward a long-term paradigm needs to be accompanied by improvements in measuring ESG factors. Currently, available ESG data often lack reliability and validity. Consequently, investment practice based on such unreliable and invalid ESG measures will not contribute to sustainable development. More emphasis needs to be put on which ESG criteria reliably reflect which type of information and organizational activities as well as how such information is actually integrated into the investment process. A greater level of transparency is also needed for the underlying screening techniques that are applied in sustainability assessments and ratings.

How Did the Authors Conduct This Research?

The authors conduct a literature review and then generate arguments based on the effective synthesis of the literature. They first revisit the scope of sustainable investments. They regard sustainable investments as a generic term for investments that seek to contribute to sustainable development by integrating long-term ESG criteria into investment decisions.

The authors explore current sustainable investment practices in more detail and examine how and why investors incorporate ESG information. They follow other researchers who categorize the investors into four groups based on the underlying logic of their sustainable investment practices: (1) financial investors, who seek to achieve superior financial performance by relying on ESG criteria; (2) deontological investors, who do not want to support irresponsible business practices and avoid investments in such assets; (3) consequential investors, who seek to influence firms by directing their investments to more sustainable firms (e.g., by voting at annual meetings); and (4) expressive investors, who focus on sustainable investments as a mechanism of enhancing their own social identity. The authors believe that only the consequential and expressive investors will pursue a long-term investment approach, which is not a large enough group to foster sustainable development.

Abstractor’s Viewpoint

Doing good by doing well seemed too good to be true decades ago. But more evidence has shown that corporate social performance and corporate financial performance are positively related and can form a virtuous cycle. To achieve this relationship, it is a must to identify the ESG criteria that are associated with financial performance. The suggestions provided by the authors offer such a win–win scenario.

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