Focusing on ESG can create more shareholder value than directly focusing on shareholder value itself, according to Alex Edmans, professor of finance at London Business School.
Speaking at the recent ETF Stream ESG ETFs Investor Workshop, he explained that ESG can justify investments with benefits that are difficult to quantify in typical net present value calculations, but investments which deliver positive long-term benefits for shareholders nonetheless.
By this logic, he contended that ESG should move from “niche” to mainstream, “because it is a way of creating value and should be something all investors take into account, irrespective of fund mandate.”
The ESG movement has been undergoing something of an existential crisis this year and inflows into ESG ETFs – while still positive – have dropped sharply as a proportion of the total.
Edmans (pictured) believes that ESG must move away from a focus on ESG metrics under the narrow ESG label and instead consider anything that creates long-term value for society. Shareholder value will then look after itself.
ESG metrics
In his presentation Edmans highlighted some issues with the current implementation of ESG, one of which is the focus on ESG metrics.
The problem with ESG metrics, according to Edmans, is that they “can distract us from what actually creates value…many long-term value drivers sit outside the ESG label.”
Referencing a Harvard Business Review article, Edmans argued a balance of financial and non-financial measures are required to assess a company and that non-financial measures are always material.
However, standardising measures across companies can be unhelpful, as something that drives long-term value for one company may be irrelevant for another.
Further, because ESG metrics are typically quantitative, “they can lead to companies hitting the target but missing the point.”
Active vs passive ownership
Stewardship is another contentious area within ESG.
Edmans is a proponent of “active ownership” and his research indicates that engaged shareholders with large stakes – often motivated primarily by investment returns – tend to have positive impacts not only on long-term returns, but on society more broadly.
To illustrate his point, he used the example of activist hedge fund Elliott Management’s campaign to save costs by eliminating inefficiencies in Costa Coffee’s supply chain. The changes implemented had the concomitant effect of reducing the company's environmental footprint.
The example raises a question around whether the rise of passive investing really is beneficial for long-term societal value, something argued by HSBC Asset Management’s former global head of sustainability Stuart Kirk at a previous ETF Stream ESG Workshop.
For Kirk, ETF investors “have more say in more boardrooms than the focused manager,” while active funds, by excluding so many companies, are passing the problem on to somebody else.
Edmans believes that the answer is more “nuanced” than this.
The advantage of passive ownership, he said, is that thanks to scale it is possible to make “market-wide improvements…by pushing through generic things across many companies.”
However, having fewer large, engaged owners risks losing the ability to make highly-tailored improvements that release large amounts of long-term value for specific companies.
