It’s widely agreed that ESG considerations are becoming ever more integrated into mainstream investment processes. But there is not the same agreement around the end goal of this integration. Specifically, should ESG investing be driven purely by financial considerations, or is creating a better world part of the deal?
To throw some light onto that question, let’s pause for a moment and remind ourselves what money actually is. That’s a question that few people ever stop to think about, even though money is so firmly embedded in modern life that it’s hard to imagine how society would get by without it.
Like many abstract things, money is best understood in terms of function, rather than form. By which I mean: once you’re clear about what money does, then what money is boils down to “anything that does that”.
One thing it does is facilitate trade, removing the need for barter. If you have something (such as a good or a service) and you want something else, you don’t need to find someone who wants to make the exact opposite transaction. You just need one person who is willing to give you money for the thing you are offering, and a different person who will take this money in exchange for the thing you want. This makes trade much much easier for everyone.
Flowing from that, money also acts as a store of value. You don’t need to do your selling and buying at the same time. Between the selling and the buying, the money is an asset.
Thirdly, it serves as a unit of account. It is the building block of financial activity, allowing us to express everything from six eggs to an hour of dentistry to an NFT in a commonly-understood language. A unit of account is basically a measure of value. So money not only facilitates trade, it also facilitates trade-offs. It reveals our priorities.
The role of money as a unit of account has expanded over time. It’s obviously fairly easy to make this work for physical goods, or for services such as a day of employment. But the more things you try to convert to a monetary value, the more you run in to problems such as non-linearity (selling one pint of your blood is one thing, selling nine would be something else) and the time value of money (financial analysis discounts the future, but the environment is not a depreciating asset). The wrinkles get bigger when we scale up from individual transactions to a higher level. Interconnectedness gets in the way: you can’t put a monetary value on breathable air, for example, because nothing else has any value without it.
Despite those wrinkles, money’s effectiveness as a common unit of account makes it our go-to measure, creating the temptation to treat it not just as one way to measure value, but as the sole proxy for all value.
The problem with money
But the problem with money is that, however hard we try, money cannot measure everything.
National prosperity, for example, is generally expressed using GDP. But GDP is not a complete measure of wellbeing, and doesn’t include everything that is of value; Robert Kennedy famously highlighted this in his 1968 Presidential campaign, arguing that it “measures everything in short, except that which makes life worthwhile.” And while today there is a burgeoning movement to find better measures of wellbeing, no single measure will ever be able to capture the whole story.
When we move from the national level to the level of an individual corporation, many argue that business should stick to business; that the most effective path to societal wellbeing is to encourage corporations to focus on their own financial interest. It’s certainly true that the typical US corporation has no formal purpose beyond simply existing: a quick look at the articles of association of Microsoft, Walmart and Apple, for example, reveals stated purposes that are each simply a variant of “engaging in any lawful act or activity that is permitted in our particular jurisdiction”. In practice, this results in shareholder profit becoming the de facto purpose driving the actions of most corporations.
But that is only an approximation of what the purpose of a corporation should be. A high-profile attempt at a more complete definition came in 2019 when the Business Roundtable released a Statement on the Purpose of a Corporation that listed as stakeholders four other groups besides shareholders: customers, employees, suppliers, and communities. Money tells us a lot about a corporation, but it doesn’t measure everything that matters here, either.
The battle for the soul of ESG investing
And let’s return to our original question: should ESG investing be driven purely by financial considerations, or is creating a better world part of the deal?
Investment, of course, is about money. ERISA defines fiduciary duty in terms of the financial best interest of beneficiaries; legislation elsewhere typically takes a broadly similar view. Best practice in ESG must be best practice in investment. And it’s notable that a big reason for ESG gaining so much traction in recent years is that proponents have emphasized the financial materiality of ESG factors. ESG investing, in other words, has become a big deal because it’s about improving financial outcomes.
But that’s not all it is.
ESG factors, by their very nature, are things that money alone doesn’t measure particularly well or where the impact is passed on – externalized – to third parties. So ESG investing begins with financial impact, but it carries us beyond that. We let ourselves down if we analyse effects like climate impact, biodiversity, human rights, and then imagine that the only part of that analysis that matters is the part that can be measured with money. That throws away too much. It’s ESG investing without a soul.