A normally sound financial rule of thumb is causing investors to pass up ESG opportunities
Because of all the information people are bombarded with, investors understandably tend to rely on rules of thumb and general principles. These generally lead to sound decisions — but even they can lead people astray.
Lauren Smart, managing director global head of the Financial Institutions Business at Trucost, recently touched on this in a blog post on the limited adoption of ESG among investors. Citing the Financial Stability Board and a recent report by the World Economic Forum, Smart said that climate is recognized as among the most impactful and significant risks facing investors and the global economy.
But “in the 2017 CFA Society ESG survey, only 50% of respondents admitted incorporating environmental issues into their investment process,” she said in a piece published on S&P DJI’s Indexology blog.
A major barrier appears to be the belief that considering climate in investment decisions requires financial sacrifice, which is fed by the “no free lunch” heuristic: weight loss requires dieting and exercise, and one must sacrifice their social life to earn their CFA, so “good” things like green products should have higher costs and lower returns.
But a more expansive reality check reveals a strong case for green investment. Unprecedented population growth is putting huge pressure on resources like food, water, and energy. The world’s “natural capital” base is being eroded by volatile weather and increasing pollution, and governments around the world are working to increase cost-to-benefit ratios for polluting industries.
Even from a financial standpoint, Smart said, green companies are predicted to do better. In a meta-study looking at environmentally efficient companies, Oxford University found lower costs of capital and superior stock-market performance among 90% of cases. Another study by Stanford University determined that carbon-efficient companies perform better on traditional metrics like ROI, cash flow, and coverage ratios.
“Even when there is abundant evidence to the contrary, we are less likely to take it into account because of confirmation bias,” Smart said. “[But] by addressing our cognitive biases, we can remove a key blocker to the flow of capital to a more sustainable economy.”