What’s the difference between sustainable fund managers and other fund managers? Not much
- Study finds that both sets of managers behave similarly, which suggests the sustainable impact might not be as big as some think.
Advocates of sustainable investing believe it could be the key to lowering carbon emissions and creating a more just society, claiming that asset managers can prod companies to do good by incorporating environmental and social factors into their investment decisions.
New research, however, suggests such expectations are probably overly optimistic.
The asset-management industry has made a significant outward show of support for sustainable investing in recent years, with thousands of firms signing the U.N. Principles for Responsible Investment and adding “sustainable" to their fund names. How these proclamations and labels affect how their managers actually invest, however, isn’t always clear.
To find out, I joined forces with Tom Gosling of London Business School and Dirk Jenter of the London School of Economics to survey 509 equity portfolio managers—290 from traditional funds and 219 from funds marketed to the public as sustainable.
Our study found that asset managers—regardless of the type of fund they run—approach investment decisions in much more similar ways than many people realize.
For example, most of the portfolio managers we surveyed—including a majority running sustainable funds—said they wouldn’t voluntarily sacrifice even one basis point (0.01 percentage point) of return to advance environmental and social (ES) goals, citing their fiduciary duty to clients. That means most managers, regardless of their fund’s label, will incorporate ES factors into their investment decisions only if they believe doing so will boost financial returns, or if they are forced to because of fund mandates. And, when asked what drives a company’s long-value, managers in both camps ranked ES factors as significantly less important than several other issues.
Value drivers
We first asked managers to rank ES’s importance to long-term firm value against five other factors. Both traditional and sustainable investors ranked it last, below strategy, operational performance, governance, corporate culture and capital structure, in that order. The fact that they ranked it significantly below governance was notable, considering environmental, social and governance (ESG) issues are commonly bundled together.
This low relative ranking doesn’t mean managers view environmental and social factors as irrelevant to company value in absolute terms. Indeed, when asked to rate the financial materiality of eight specific ES issues such as greenhouse-gas emissions and employee well-being, 85% of respondents, including 78% of traditional fund managers, rated at least one ES issue as material. But it does mean that a manager’s ability to assess strategy and operational performance is much more important to a fund’s performance than its ES metrics, the disclosure of which has become a growing focus of regulators.
Next, we explored company stock-market returns and again found similarities between the two camps. In our survey, 73% of sustainable managers expect the companies they see as top performers on environmental and social issues to deliver positive returns, and 45% of traditional managers agree. But even sustainable managers believe strong ES performance doesn’t directly drive higher returns but rather is a sign of a well-managed company. Well-managed firms, they say, tend to excel in multiple areas.
At the same time, a majority of both sustainable and traditional fund managers—67% and 61% respectively—believe companies that perform poorly on environmental or social issues will deliver negative returns. This suggests that sustainable funds aren’t the only ones paying attention to ES issues. Many traditional funds take ES into account, too, because they think it can affect their returns.
Fund constraints
Some advocates might say the difference between sustainable and traditional investing is that sustainable investing isn’t focused solely on moneymaking.
Yet only 27% of the managers we surveyed (24% traditional, 30% sustainable) said they would voluntarily tolerate the sacrifice of even one basis point of long-term return in support of ES objectives. “We could never accept lower risk-adjusted returns out of the goodness of our hearts," one manager said. Another stressed that a mutual fund’s purpose “is to maximize risk-adjusted returns for the public. It would be unethical and illegal if I deviated from that purpose."
The same principles guide how fund managers vote on shareholder proposals. While 78% of portfolio managers say they have voted for ES shareholder proposals that they thought were neutral for shareholder value, only 27% (24% traditional, 31% sustainable) say they have ever voted for a proposal that was even slightly negative for shareholder value, citing their fiduciary duty.
One force that can cause sustainable investors to deviate from maximizing return are fund constraints. These are limitations on the kinds of companies and sectors in which a fund is allowed to invest. Eighty-four percent of sustainable-fund managers say firmwide policies, fund mandates, client wishes and reputational concerns have led them to make different investment decisions than they otherwise would have. Yet we found that ES constraints aren’t unique to sustainable funds. About two-thirds of traditional fund managers have had to make different decisions, too, to address clients’ ES concerns, many of which appear on due-diligence questionnaires.
Realistic expectations
What do these results mean? First, environmental and social factors can be used to achieve the same goal as any other investment strategy—to make money—which is why many traditional investors pay attention to them. ES investing is an investment style, a way of improving long-term financial returns that is neither more or less valid than, say, value or growth investing. Even if ES doesn’t directly drive returns, it can be a useful signal of other factors that do.
Second, policymakers and the public need to have realistic expectations about the asset-management industry’s likely ES impact. It will invest in ES leaders that offer superior financial returns, and vote and engage on ES issues that are financially material. But it won’t subsidize ES investments that offer below-market long-term returns, or stop companies from engaging in profitable activities that harm society.
Third, fund labels can be misleading. Individuals often view names as a signal of a fund’s investment approach. But as our research shows, many sustainable managers see financial returns as their main priority, and many traditional managers take ES into account if they think it is financially material. Therefore, investors who want sustainable portfolios need to look beyond the label and scrutinize a fund’s actual stock selection, voting and engagement.
Alex Edmans is professor of finance at London Business School and author of “Grow the Pie: How Great Companies Deliver Both Purpose and Profit." He can be reached at reports@wsj.com.
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