Elroy Dimson
Professor of Finance, Cambridge Judge Business School and London Business School *
*In conjunction with Paul Marsh and Mike Staunton,London Business School.
- The UN-supported Principles for Responsible Investment today lists 1,385 signatories with investment assets of US59 trillion
- The Global Sustainable Investment Alliance estimates that, worldwide, portfolios valued at over US21 trillion incorporate environmental, social and governance concerns.
- The UN Global Compact reports that 13,026 organisations in 170 countries have now committed to responsible and sustainable practices.
- As owners they are complicit: they share responsibility for a firm's actions. This is the notion that underpins the screening processes followed, among others, by the Norwegian Government Pension Fund and by faithbased investors who exclude certain companies or industries the activities of which offend the investor.
- Investors can influence companies. They can use their leverage to persuade the executives of businesses they own - or their regulators, judiciary or other influencers - to improve company behavior based on their beliefs about social justice or in the interests of stakeholders.
- Long-run returns may be enhanced by taking advantage of the 'universal ownership' of major investors, who are exposed to almost every company and have long investment horizons. Indeed, since many people invest through mutual funds or pension providers, the managers of globally diversified pooled funds often engage with companies in the interests of more modest investors, thus less wealthy individuals may also be universal owners.
Universal owners cannot escape costly, company-specific factors. If one firm benefits at the expense of others, there may be no net gain to a diversified asset owner. Universal owners should, then, strive to increase the aggregate value of all corporations. Aggregate value is destroyed when a business maximises its profits by imposing externalities on competitors and society.
When it comes to responding to unacceptable corporate behaviour, investors have a choice between exit or voice. Exit - sometimes termed the 'Wall Street Walk' - involves excluding 78 the shares of companies, industries or countries with unattractive attributes. Sometimes this will have little overall effect. However, in the case of an active owner, the very fact of exit may apply pressure on a company or industry. This pressure is heightened when a number of investors divest together.
Voice involves engaging with the company or pursuing other methods for amending the behavior of the firm.
Paradoxically, much of the evidence suggests that 'sin' pays, that investment in less responsible companies, industries, and countries has tended to outperform. This runs counter to the stance of many ethical investors who emphasise 'doing well by doing good'.
Ironically, the actions of ethical investors may compound this problem. If, through exit, responsible investors depress the share prices of noxious businesses, these 'sin stocks' may become attractive to investors who are relatively untroubled by ethical considerations. Expected financial returns are likely to be higher (due to the relatively low price) which can compensate for the emotional burden of owning offensive companies.
A corollary is that just buying shares in responsibly and sustainably managed companies cannot be seen as a winning investment strategy. Investors therefore face a challenge: should they divest from objectionable stocks, or should they use voice to make target companies more acceptable? The decision depends upon a number of factors including: loyalty - how strongly they feel about retaining their stake in the company; the potential return loss and reduced diversification from divesting objectionable stocks; and the scope for changing businesses for the better.
Importantly, engaging with investee companies has been shown in a number of studies to be financially profitable as well as effective. It is also a key step in making capitalism more inclusive. It is insufficient for investors to omit certain companies from their portfolio. They must be willing to engage in processes of change.