"It's not that ESG or responsible investment is going in the right direction just slowly [...] It is wholly misdirected. Which is why some tough thinking in the form of the EA community could play a role in changing things."
Dr Ellen Quigley is a Senior Research Associate in Climate Risk & Sustainable Finance at Centre for the Study of Existential Risk, and is also the Advisor to the Chief Financial Officer (Responsible Investment) at the University of Cambridge. Sanjay Joshi is the CEO and Founder of SoGive.
Relevant reading includes:
- Paper: Ellen Quigley: Universal Ownership in Practice: A Practical Positive Investment Framework for Asset Owners
- Report: Divestment: Advantages and Disadvantages for the University of Cambridge [see Appendix IV: Impact analysis across asset classes & Appendix V: efficacy of shareholder engagement]
- EA Forum post: Sanjay Joshi: The $100trn opportunity: ESG investing should be a top priority for EA careers
- EA Forum post: Sanjay Joshi: ESG investing isn’t high-impact, but it could be
Effective ESG investing is important, tractable and neglected
Sanjay: There are two posts that I recently put up on the EA forum. The first one is the $100 trillion opportunity post and that's a bit more focused on the EA community in particular. I'll just go through that one very quickly first. It claims that ESG investing is currently not high impact, but it could be. I don't want to spend too much time on the language here, but I'm talking about ESG, responsible, [and] sustainable investing roughly synonymously each other.
Sanjay: So I applied the ITN framework here. I argue that it's big. The $100 trillion comes from the UN principles for responsible investment. And to get a sense of scale here, a hundred trillion dollars: it sounds like a lot and it is a lot. It depends on how you measure the total invested assets, but it won't be in the quadrillions, it'll be in the hundreds of trillions, so a material proportion of overall invested assets.
Sanjay: There's an interesting claim about tractability here. I would argue that it's probably a pretty good place for tractability. And I say that because there is a huge amount of ESG investment responsible investment massively taking off recently. So that means we're actually at a great time to make things happen in this space because the space has got enough traction that you can make things happen, but it's still young enough that it can be shaped.
Sanjay: And then in terms of neglectedness, I think I'm pretty positive on this as well. There are some nuances about exactly how you define neglectedness. I'm pretty much following the Owen Cotton-Barrett definitions, using the mathematics that he employed. And under my interpretation of that approach, the number of people in finance isn't necessarily the right thing to look at, but rather how many of them are actually trying to achieve impact motivated ESG. And arguably, if those people are trying to do what I call impact inward approach to ESG investing (i.e. what are the risks that my company is exposed to because of ESG factors and not what risks is this company causing because of the environment, social issues or whatever), then we're missing a big part of the story. And this distinction between impact inwards and impact outwards means that a lot of people are focusing on or trying to do what you might arguably call the wrong thing.
There's an interesting thing here about the fact that EA community has not really given a lot of attention to this area. And so the reason for that, I argue, is that there's been a focus on a normal individual. And if you've got that perspective, then the conclusion [is that] it's pretty hard to have a lot of impact as an impact investor. Pretty reasonable conclusion, in my view, but this whole piece on the EA Forum and the adjacent one [are] about a different question. [They're] about: "Can we, collectively working together, improve the whole system so the whole system has more impact?" And that perhaps is why the EA community has neglected it despite the fact that it's potentially really impactful. So that's a quick canter through that first post.
Sanjay: In this other post, which is quite a bit longer, I alluded to this distinction between inwards impact and outwards impact (which I've just spoken about a moment ago) and fiduciary duty. I won't spend too much time on that. The whole legal rigorous regulation system is exacerbating this problem of too much focus on inwards impact [and] not enough focus on outwards impact.
Section 3: Universal ownership can partially solve this problem
Sanjay: I introduce this term universal ownership. It also links to a post by Ellen on the topic of universal ownership (which is obviously a great read if you can have a look at that as well). And I won't say much more about universal ownership if we have Ellen here; I'll leave that to her.
Section 4: Effective influence is possible
Sanjay: A really important thing is, and this is part of the tractability point, that this article is entitled "ESG investing isn't high impact in the current state of the world, but it could be". And this section says [that] there is a way that this world of ESG investing could actually have real world impacts on the wider world. And as an example of that, really good strong engagement in terms of equities could be effective (and a few other things as well).
Section 5: Cause areas: the finance world has not chosen themes systematically
Sanjay: And then one other thing, and I think this is particularly important to those of us from an EA background: we are used to the idea that choice of cause areas is important. And we are used to thinking really hard about that stuff. If you encounter people in the world of ESG investing and responsible investing, and you asked them what the most important topics or cause areas to focus on when it comes to the issue of responsible investing, it's really common to hear the answer: "climate change is the most important thing" - why? - "well, it's just obvious". No more further thought needed. And I think there's a real opportunity to get the thinking about this to be much more rigorous and to open out that world to other high impact cause areas.
Section 6: Action: Which job to get if you want to take action
Sanjay: Another thing that I think is useful to allude to is Section 6 (possibly useful enough that maybe I shouldn't have hidden it halfway down this rather long post). But I set out here a bunch of different areas that you could work in if you decided that you want to work in this space.
So individual asset owners. You can't work there; [they're] just normal people like you and me need passing their money to pension funds, life insurers, things like that. They, in turn, get asset managers (this could be BlackRock or Vanguard or Alliance-Bernstein or whoever) to manage the funds. And then these funds are in companies or other issuers of securities. And I suggested in here: what does [success] look like? It's when the asset managers (the BlackRocks, the Vanguards, those people) have become really impactful in the way that they engage with firms and issuers. And then I, somewhat boldly, given that arguably [I've] not had enough time to properly review this, [have] been courageous enough to put a star rating on each of these in terms of how impactful they are.
And I suggest that [as an institutional asset owner] you can have some impact. That's not the best place to work, for example, [for] a life insurer. But a consulting firm that's exposed to lots of [institutional asset owners] could be really good. And then [proxy voting firms and ESG rating agencies] could have loads of leverage because, for example, if you're an asset manager, you'll probably lean pretty heavily on what ESG rating agencies like MSCI and Sustainalytics have to say. And some of these other things [such as reporting frameworks, academics, NGOs, regulators etc.] could be potentially be really high impact as well. I probably don't have time to go into each of those, but you can see here, this is what the table looks like. And you can see in there the different rating that I have, rightly or wrongly, given to these topics.
Sanjay: And then there are some appendices here in which I spent a huge amount of time thinking about the tools in your toolkit. If you are an investor, you could use asset allocation [i.e.] do I divest or invest? You could also engage. As somebody who owns this stock, I can say to the management: "Hey, look, don't do that bad thing. Please do this good thing." And of course you can't do both of those two things at the same time. So there's an important question about which is more valuable, and that is explored a bit here. And lots of it leans very heavily on Ellen's work.
So I've cantered through that very quickly, but that was deliberate. Let me stop there and I guess we're handing over to Ellen.
ESG investing is wholly misdirected
Ellen: Thanks, Sanjay. So I'll maybe just iron over a couple of things that Sanjay has said, just cause I feel like they're pretty critical to return to. And then I'll maybe add a couple of my favorite targets and explain universal ownership and the reason that I view divestment as being compatible with it now, although I've changed my mind about that in the last year.
So first just to really reiterate, it's not that ESG or responsible investment is going in the right direction just slowly or something like that. It is wholly misdirected. Which is why some tough thinking in the form of the EA community could play a role in changing things.
ESG is not concerned with real world impact
Ellen: ESG is, as Sanjay said, concerned with the impact on the companies and portfolios. So they're a risk abatement tool and they're pretty good at that. They may protect your portfolio a bit from the climate change that they'll do nothing about, for example, but they're not even aimed at or focused on whether or not that company or fund has an impact on the real world, which is the real issue that we would all want to tackle if you want to actually have an impact and actually solve some of these huge systemic risks that we face. There's no good stock picking in the stock market. That's really truly rearranging deck chairs on the Titanic. It does not matter whose shares you own or don't own. That's a symbolic matter because that's the secondary market. It's all about what kind of new capital is flowing to companies. So that's how you have an impact with your actual money. I'll come back to this in a second.
It's all about stock picking in other asset classes and engagement in public equity
Ellen: I think that there are ways to have an effect across other dimensions, but if you're just talking about the impact of cash, it's just useless to be looking at the stock market and picking which shares you buy. So if that's your attitude, then you have to flip things around. So responsible investment is all about stock picking and public equity. As Sanjay has said, you'll want to do a lot of engagement in public equity because that's how you can actually affect the behavior of companies. And then you'll want to do the equivalent of stock picking in other asset classes where new money is actually flowing to things. I'm going to keep returning to climate change as my example, but there are a lot of other things that you can use this on. So antimicrobial resistance is something we've been working on lately, for example.
Focus on debt and banks as a primary target
Ellen: So if you're flipping things around like this and you're having an impact by asset allocation in other asset classes and through engagement in public equity, then it's really helpful to think about the targets as Sanjay has done. But I just want to add two more and one of which I'm surprised that he didn't include, because I know that he thinks about it a lot and that's insurance but the other one is banks. If you look at new money that's flowing into fossil fuels, about 90% of it comes from debt. So that's largely bank loans and quite a bit in the way of bonds or fixed income as well. So that's all flowing through banks. So, and that includes, in fact, initial public offerings and a lot of other kind of underwriting activities for the capital markets.
So if you look at the full spectrum of new capital that's currently flowing into fossil fuels, just as an example, you end up with a picture in which banks are your primary target: they're the ones controlling or directly contributing this money to these new uses. And if you're like me, you're trying to look for the leverage points. In my view right now, the leverage points are trying to stop new infrastructure from being built and stop new exploration and development of new fossil fuel resources, because that's where the vast majority of emissions come from.
So if you have that kind of leverage points and impact analysis lens, which I know you all do because you're EAs, then that really helps narrow down your focus. And because if you look at who are these big banks that are providing the vast majority of the capital, they're actually only a few dozen of them doing this, that account for the vast majority of this new financing. So if you happen to be a banker at one of the top 40 banks in the world, you yourself have a big chance to do something in this area.
Individuals can help apply pressure on decision-makers
Ellen: And as much as I don't think that individual actions are very useful in this space, to be honest. The one useful thing you could do is actually switch banks right now. And that is actually slightly impactful directly. But also banks and asset owners like pension funds don't hear from customers about this stuff ever. I talk to the people on the backend here all the time, and they never hear anything about it. It would be a banner year for them to hear from five pension holders as to what the pensions policy is on any of these issues. So I do hope that actually each of you will go switch your bank and write to your pension fund. And although those, those are activities that will not take you very long at all. It could actually really help somebody internally in either of those institutions to increase the pressure on the decision makers.
And that's one of the dynamics I think we have to think through in this whole space is like, how can we provide the fodder for people who are inside trying to make certain things happen? How do we give them enough weapons to do battle? And honestly just a very small number of of people saying anything to these players would make a big difference at this stage and would constitute a big rise in direct communications because people aren't aware that this is how the system works. So they don't know where to apply pressure typically, so write to your pension fund and switch banks. Triodos is a great bank. So I think anywhere in Europe and the UK, you can switch to Triodos, if that's useful.
Universal ownership can contribute meaningfully to addressing many issues
Ellen: But I just wanted to describe universal ownership to you all for a moment. It's the idea that a large pension fund or sovereign wealth fund or university endowment owns a more or less representative slice of the whole economy just because it's a diversified and long-term, and if that's the way that you work, then you have to pay attention to externalities. There's basically no such thing as an externality if you're very long-term and diversified owner of capital, because the costs from one thing, let's say Exxon and their emissions, end up getting picked up elsewhere in your portfolio.
So I guess this is just to say that luckily there actually are some heroes in the wings here and that's in the form of these giant boring institutions that we barely ever think about that own the majority of capital and certainly have power over the BlackRocks and Vanguards who deploy that capital. So those are really the nexus of capital deployment.
And if they were to behave as universal owners, they would do exactly as Sanjay and I have both been saying, which is that they will typically engage in public equity in the secondary market and the primary market. They will be really careful as to what they own so that it doesn't contribute to huge risks like climate change or anti-microbial resistance or a bunch of other things. So that's why it's actually a very useful framework. It means that there's a very good reason for some of the biggest players in the whole economy to think this way, and we can help them to think that way.
If they do, that's really bit of a game changer. As we've discussed in the past, it doesn't solve every single thing. It doesn't solve minority rights issues and other things like that that are still very important, obviously. But it can go a long way towards a whole bunch of issues, including climate biodiversity, inequality, including diversity issues, anti-microbial resistance, pandemics. You can go through a very, very long list of things and universal ownership could contribute meaningfully to addressing them.
Divestment's theory of change only makes sense for institutions with clout in society
Ellen: And then finally, just to say that I don't now view divestment as being incompatible with all of this, mainly because there's a different theory of change. So I wouldn't advise this necessarily for like a big punch and fund no one knows the name of. But I'm at the University of Cambridge and I do think it's the right call for Cambridge to have divested because although we have a large endowment by university standards, it's pennies compared to the whole system, and we have a lot more clout than we have money, in which case the theory of change for divestment actually kind of makes sense.
The theory of change being that we don't tend to get the legislation that we need to address issues like this. And climate change, for example, is one that really does require a lot of legislation. We don't tend to legislate things that we don't view as wrong. And we're unlikely to to legislate or regulate fossil fuel companies appropriately unless they are properly stigmatized. And that's what divestment does. So it actually gets at quite a systemic issue, which is support for fossil fuels and/or their lobbying power. This is a way of countering all of that and building support for the legislative/regulatory change that we actually need.
So anyway, I think there is a justification for using that tactic for any institution that has a lot of kind of clout or legitimacy in society. And just to say you can deploy that in a whole bunch [of ways]. You should do both anyway. Just because you divest, you own every other company in your portfolio. So you should be engaging regardless of whether you divest.
Responses to questions
Working in finance is a better leverage point than working directly in corporates
Q: What is the reason you only focus on people working in finance (BlackRock etc.) to influence and not people who work in the corporates themselves?
Ellen: Look, if the problem is there are too many thousands upon thousands of listed companies in the world. And if you took the top hundred asset owners in the world, you could deploy much of this without any trouble. So it's really just about leverage points. Sanjay might have a different answer from mine.
Sanjay: There might be specific companies where it could be valuable. So if you were to take an investor relations role, for example in Exxon say, then I still think it's probably more valuable to be on the side that has the power, like the side that has the money. And it's just tricky to get other people who can make the demands. But if you're on the receiving end of those demands, I mean, first the demands have to be made, right? I mean, you have to take the finance systems that they're making the demands, but once happens then having somebody on the [unclear] side is hearing those and feeding those back to management within Exxon, there could be some scope for that person to help to highlight the fact that these demands are there. But I sort of see that as probably less valuable, I'd say, then actually being on the side where the money is and using that to make powerful demands. And just to say, if you're inside a company, you aren't going to be able to make transformative change without huge pressure from your investors anyway. So might as well go to that initial leverage point.
ESG is not doing enough; don't forget about bonds
Q: Can individuals can help by demanding ESG funds in their 401k or retirement options?
Ellen: So I just want to caution. I would argue that is not enough. And you have to ask them whether they're applying the same filter to the bond part of your portfolio, just to start with. But ESG is crap. It just is. Sorry to put it that way, but it's useless unless it's applied very rigorously to the primary market part of your portfolio, and that almost never happens. Which is actually part of the other reason that I'm sort of sympathetic to divestment calls. Because if you say divest everything and across all asset classes, it's hard to get out of that. But otherwise, ESG is just not enough. Ask about your fixed income portfolio though. And make sure that that doesn't have any company that you wouldn't want your money flowing towards.
The voting and engagement record of funds are important
Q: Is investing in ESG ETFs a good choice?
Ellen: Okay. So I'm sorry to push back, but it doesn't matter. [A 'bad' corporate] is not helped or hurt by your investing in an ESG ETF. Unless you have a bond ETF, which is pretty rare, you're not helping or hurting any of those funds. What you could do is see what the voting and engagement record is for the company that ultimately controls that for your ETF. But other than that, it's really not going to do anything. I'm really sorry. It feels like I'm delivering bad news. Sanjay, do you have anything to add to that?
Sanjay: No, I agree. I think it emphasizes why the focus here is on people working in the sector because we need people who are passionate about making change to work in the sector. So that what Ellen has just said is no longer true a few years in the future.
Ellen: Yes. And by the way, just a couple of things to look for. If you do get nerdy about this and look it into your pension fund for example, what you want to see is that they vote against the re-election of directors on the engagement side. That's how you know whether they're really ahead of the pack or not because that's much more effective than voting on shareholder resolutions, which they might try to talk to you about. They should be voting against hundreds of directors at the very least if they're really serious about this. And then again, do look at the names in the bond portfolio if you have one, because that's where it actually matters.
There is no meaningful shift in share prices as a result of divestment
Q: Don't corporates do secondary equity offerings all the time? So aren't secondary market prices still very important?
Ellen: So I've reviewed the evidence on this. It's really, really hard to shift share prices at all. But even if you do, it's hard to trace that back to any change in company behavior, you'd have to change the share prices quite considerably.
Sanjay: I think there is something analogous if we look at the world of debt versus equity, so [this] point about if you've issued whatever it is, equity in this case, then you're issuing again. Then this whole divestment stuff will matter. That's much more the case in the world of debt. Debt, by its nature, equities are perpetual; they exist by definition forever. Debt is defined almost always to have a term on it and to come to an end after whatever it is, five years or 10 years or whatever. I think it varies a little bit, there's probably quite a lot of companies that don't actually issue equity pretty much. They don't do equity basis very often.
Ellen: In fact most don't now, honestly, you're more likely to see share buybacks now.
Sanjay: But in the world of debt, I mean, it definitely does. It is the case that you issue debt, you are expecting to be back at the market in a few years' time refinancing that debt and probably having more issues in the meantime. You'll probably go into the debt markets all the time.
Q: In pure economic theory, the equity price determines the extent to which the company is expanding their operations, right? Because if their equity price is higher relative to their assets, that means that investors want to see the corporation to expand their operations. Then if the market cap is less than assets, that generally means, in economic theory, that the company should be contracting. So it seems like even if you're not directly funding it, you're signalling what will end up happening in the debt market.
Ellen: Yes, but you're describing why it's impossible for anything to happen due to ethical concerns. Like those are things that are driven by the market. And I can put a link in the chat if useful, cause I've reviewed all the papers on this. You're just not going to see a shift, a meaningful shift, because of even the largest sovereign wealth fund in the world, which is over a trillion itself. When it divests, there is a small hit to the share price of the company involved on the day of the announcement, not the day that they actually sell the shares. It can be before or after. The market seems to think that there is a logical price for something, and that's not going to be affected by people's ethical preferences, sadly.
Q: Yeah, I agree [inaudible] is the only thing that ultimately matters, but I'm just not at all convinced that the fixed income somehow matters for the equity.
Ellen: Well, there has been already a small effect on the cost of capital on the debt side. And that is just because these companies are coming to the market all the time. So the companies that we're talking about, they are not issuing new shares. That's not a thing that they're doing. They are, if anything, buying back shares and then issuing a lot of debt and because they have to do that frequently enough, it is starting to affect their cost of capital already. They're starting to get banks reluctant to extend quite as much and especially not on the same terms. And I actually expect that to increase quite a bit because most people who divested until recently weren't thinking about their bond portfolio. So that's the effect that we're seeing just based on kind of social opprobrium and a bit of divestment. But I actually expect to see much more of it.
Universal ownership can work for all the investors who just want to make a return
Q: When we donate, we technically don’t expect to earn anything in return. I imagine that many people would treat investments similarly (I’m investing to do good vs. donating). But for those that are expecting to make a return, do you have any perspectives on the risks of switching from say a total market investment to an ESG investment?
Sanjay: And so one point to make is [that] our focus is absolutely on the massive pool of investments from people who are wanting to make a return. The people who say "I'm really focused on doing good with my money" and they're not fussed about whether they're going to get a return: that is a tiny, tiny drop in the ocean. So we're focused on the big pool of money here. And I'd say universal ownership is a fascinating angle that enables us to be more pushy on the impact outwards and actually have an impact even within the paradigm of "I'm an investor who just wants to make return".
Junior people in ESG may be able to have impact quickly
Q: How can a junior professional have leverage within their organizations, given that the finance industry tends to be hierarchical? Having worked at an institutional asset owner (large endowment), it seems to be at least a 10-year project before one could have a meaningful impact on informing the institutional decision-making of the portfolio.
Sanjay: I think, speaking as my journey of having been junior and then having been more senior, I pretty much agree with that. I think it is actually quite difficult to have a lot of leverage when you're junior. And I think the reality is you will probably have some influence. You'll have the capacity as somebody who's quite junior to raise questions about things and make sure that certain perspectives and voices and things are heard. But it's going to be pretty hard for you as a junior banker or actuary or whatever to really shift the needle. But you can point people towards other people who have got more influence. And that could be a way of having that bridge.
Ellen: Also, just to note this field is exploding. So one can start out quite junior and end up being quite senior in a ridiculously short period of time. It's probably much faster. If you're looking at almost anything else where you need seniority to actually have an impact, this would be a faster route up the chain than in almost any other field. They're playing musical chairs now among the people who lead the major ESG shops in the big funds. And they're just desperate for new blood. It's a crazy time to be in the industry. So you can rise pretty fast. I wouldn't see it as a ten-year project necessarily if you're really skilled.
Debt is a massive opportunity, but any leverage point is good with the right impact approach
Q: It seems you both have focused more on public equities. Do you believe traditional asset management has more of a potential to create an impact vs alternative asset management like private equity and growth equity, perhaps because of its size?
Sanjay: So one point to make is definitely not just focus on public equities. I think both of us would probably say that there's a massive under focus on debt which can be hugely important. And that's particularly the case because if you're issuing equities, then you've got lots more public disclosure requirements. Whereas at the moment if you're issuing debt, who do you talk to? Well, you talk to an investment bank and quite a lot of it's behind closed doors. So if you're doing something dodgy, like tobacco or being a fossil fuel company or something like that, debt suddenly becomes a whole lot more attractive. Ellen's got some really great charts in some of her papers about just how heavily focused fossil fuels is on debt. And so that means that if we can take the attention more on debt, there's a massive opportunity there. But I think [this] question was also about: what about alternative asset management, things like private equity and so on. And I haven't discussed this with Ellen, but my answer to that would be: I'm just going to the biggest stuff. And that's the reason for focusing on that to my mind.
Ellen: Yeah. There's a good reason though for choosing pretty much any part of the chain, as long as you have the right lens. So you could be in venture capital and that could be very high impact because that's how companies grow in the first place. Private equity is kind of like the next stage in development. And then once the child is all grown up, then they list on the stock market and at the IPO stage actually is another huge leverage point, I would argue. And then the debt side obviously is huge too. But I think as long as you have this impact approach, then any part of of that would be very useful.
Q: The way I think of it is ESG is a term within the financial industry related to investing with larger societal/environmental considerations, while CSR (corporate social responsibility) is the same coin on the company's side, i.e. how to do business with societal/environmental considerations. And CSR is quite common among large companies.
Sanjay: Agreed, thank you.
Ellen: Sorry, can I just note something, which is that usually CSR is crap too. These things are usually good for marginal recycling programs or something like that.
Q: Doesn't encouraging one portfolio company to do something to help the rest of your book fall afoul of antitrust laws? Collusion via pressure from common ownership?
Ellen: So investors can collaborate all the time on shareholder engagements. That is a normal thing to do. There's certain things that they have to be careful about in order to not run afoul of acting in concert rules and that's stricter in some countries than others. But there are international coalitions working on something every day. So you have to be careful, but you can do it safely and legally.
Q: Unlike publicly-traded securities, presumably seed funding, angel investing and venture capital are considered new capital and are potentially impactful.
Sanjay: Agree with that.
Q: Can you think of any NGO initiatives/campaigns that have stood out as being impactful in ESG regarding climate change in the debt market?
Sanjay: [As for] my organization, SoGive, I think I would very much like us to do some reviews on charities, like ShareAction, for example, and see if they have done something like that. I don't have a rigorous answer there but we're in conversations with them; maybe they are going to be really good. The Emerging Markets Investors Alliance is a charity that would like to have lots of EA people involved, so maybe they'll be very high impact. I've not done a proper assessment of that.
Q: What banks and investment platforms do you recommend?
Ellen [in chat]: Good bank for Europe/UK is Triodos. In the UK, good direct investment platforms for renewables: Energy4All, Thrive Renewables, Abundance.
Q: Are we asking too much of ESG?
Sanjay: I would say we're using things like universal ownership and the fact that there actually are things we can do that will really have an impact. That combination of things says to me: I don't think we aren't asking too much of ESG. I think great things can happen.