Do you really want to change the world with ESG investing?

Invest in companies that 'try to solve the world's problems rather than just do no harm', says London Business School finance professor

Do you really want to change the world with ESG investing?

Investors should support companies that try to solve the world’s problems rather than those that just “try to do no harm,” a London Business School finance professor from England told Franklin Templeton’s webinar yesterday.

Alex Edmans, who talks to both asset managers and assets owners, such as pension funds, shared a new way to look at environmental, social, and governance (ESG) investing during the Global Investment Outlook online gathering. He outlined the ESG framework that he developed in his 2020 book, Grow the Pie: How Great Companies Deliver Both Purpose and Profit, which builds a business, as much as a moral, case for ESG investing.

“I believe that, in 2021, it’s not enough for businesses just to do no harm. Given the scale of the world’s challenges, automation, climate change, inequality, and so on, it’s not enough for a company not to contribute to these problems. They must actively take action to try to solve them,” he said, urging investors to support companies that actively try to create more value in society.

“I’d like to shift our thinking about responsibility away from just splitting the pie, so that it’s fairer, toward actively creating value through growing the pie,” said Edmans. He added that the traditional practice of trying to redistribute fairness isn’t working because companies don’t typically follow through if there’s no profit in it. 

“It isn’t about giving society a greater slice of what’s already there, but it’s about an innovation to excellence through actively creating value,” he said. “This is the power of ESG investing: trying to think about things that are creating social value rather than directly making profit. Ultimately, you might be able to monetize it.”

Edmans said companies that “tick” all the ESG boxes don’t necessarily beat the market. Those who tick some boxes, but do it well, are usually more successful. He suggested investors should define what’s important to them and choose companies that meet that criterion, then do a ‘net benefit test’ to see if the companies provide more good.

Edmans said investors should consider excellence, which isn’t a traditional ESG criteria, but is one of the core things a company can do to serve society. “By being excellent at something, it can help thousands of people around the world,” he said.

Next, investors should consider the comparative advantage the company has in order to focus on those firms have the expertise to make a difference. “Companies that do create value, if they focus on materiality and comparative advantage, ultimately do become profitable in the long-term,” said Edmans. The leaders who use their resources to shift society are doing more good in the long run, so supporting them unlocks more possibility.

Considering all these factors can help investors develop a new approach to ESG integration. That can make more difference since ESG factors differ by country. Those investors who simply look at data may miss the mark of truly shifting society. Some energy companies are actively developing alternatives, for instance, while companies like Mercedes have shifted from formula one engines to creating breathing machines to help with COVID. So, Edmans said investors need to understand quality, and not just quantitative metrics, if they truly want to make a difference.