ESG as Waving Banners and as Pulling Plows

  • Meir Statman
  • Journal of Portfolio Management, 2020
  • A version of this paper can be found here
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What are the Research Questions?

There are a number of definitions and names for ESG Investing that circulated through the years ( as we previously covered here). All are indications of a movement that started years, if not centuries (see for example the Quakers in the 1650s) back. The author of this article has one main goal: to illustrate how the ESG movement lost its way once it was redirected from doing good (Building houses for the homeless) to doing well (generating alpha with ESG) or as the authors phrased it: “from plow-minded investors to waving banners-minded investors.”

What are the Academic Insights?

According to the author, there are three types of ESG investors:
  1. Pseudo ESG investors – Utilitarian return seekers and indifferent to expressive and emotional benefits,
  2. ESG Banner-minded investors – They might want expressive and emotional benefits for themselves, but they are unwilling to sacrifice any portion of their utilitarian returns. For example, those who apply negative and positive screens to their portfolios or those who invest in projects that carry ESG labels, such as wind farms or solar energy, but that promise returns equal to or higher than market returns
  3. ESG Plow-minded investors – These are investors willing to sacrifice portions of their utilitarian returns for their own expressive and emotional benefits as well as for the utilitarian, expressive, and emotional benefits of others. Examples of plows are: investments that benefit others, such as the homeless, but provide below-market returns to their investors; consumer boycotts of shunned companies; offers and promotion of corporate proposals that move shunned companies in ESG directions; and political actions to change laws in ESG directions.
And what about the relationship between return and ESG ratings? There is conflicting academic evidence but according to the author, there are three hypotheses:
  1. “Doing good but not well hypothesis”, in which the expected returns of ESG stocks are LOWER than the expected returns of conventional stocks, which might be true if the ecnomic gains of company actions that tilt it toward ESG fall short of the costs and investors are aware of the decreased returns.
  2. “Doing good while doing well hypothesis”, in which the expected returns of ESG stocks are HIGHER than those of conventional stocks, which is possible if managers and investors consistentl underestimate the benefits of ESG or underesitmate it costs.
  3. “No effect hypothesis”, in which expected returns of ESG stocks are EQUAL to the expected returns of conventional stocks and might be true if aspects of ESG that are consistent with the doing good while doing well hypothesis are counterbalanced by other aspects that are consistent with the doing good but not well hypothesis or when costly company actions increase benefits by as much as they increase costs
The ESG movement started as plow-minded but has evolved by adding banner-minded investors and pseudo-ESG investors. According to Hartzmark and Sussman (2019), newly categorized ESG mutual funds saw record net inflows of more than $24 billion. However, these funds did not deliver excess returns. However, the good news is that there is ample evidence that many ESG investors are plow-minded. See for example, Riedl and Smeets, 2017 and Rossi et al., 2018, who found evidence of investors willing to sacrifice portions of utilitarian returns of their ESG investments, whilst paying higher fees.

Why does it matter?

This paper is an important addition to the academic debate around ESG investing and whether it holds a place in investor portfolios. Depending on what an investor’s goals and values are should play a role in supplying “plow like” or “banner like” ESG portfolios. For some, economic returns are the primary concern, and for others, putting their capital to use for social returns could be much more important.

The Most Important Chart from the Paper:

There were no charts in this paper!
Photo by LinkedIn Sales Solutions on Unsplash

Abstract

Environmental, social, and governance (ESG) investors who do no more than exclude stocks of fossil fuel producers from their portfolios are banner-minded; they want to do well and expect to earn market returns, if not higher. Banner-minded investors might want the expressive and emotional benefits of staying true to their values, but they are unwilling to sacrifice any portion of their utilitarian returns for these benefits. More importantly, they do no good, doing nothing to enhance the utilitarian, expressive, and emotional benefits of others. ESG investors who invest in housing for the homeless, however, are plow-minded; they want to do good and are willing to accept lower than market returns. Plow-minded investors want the expressive and emotional benefits of staying true to their values, and they are willing to sacrifice portions of their utilitarian returns for these benefits. More importantly, they do much good, enhancing the utilitarian, expressive, and emotional benefits of others. In the last few decades, the ESG movement lost its way as it transitioned from doing good to doing well and from plow-minded investors to banner-minded and pseudo-ESG investors. That transition expanded the ESG movement by adding investors but degraded the movement from doing good to doing well. It is time for the movement to regain its way, transitioning back from doing well to doing good, from banner-minded and pseudo-ESG investors to plow-minded investors, and from wants for utilitarian returns for oneself to wants for utilitarian, expressive, and emotional benefits for others.

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