The problems with sustainable investing

There's little oversight when it comes to ensuring companies meet their environmental targets. Photo / Getty Images

Over the past 20 years many academics, consultants, executives and nongovernmental organisation leaders have promoted a theory outlining how businesses can prosper while pursuing a greener and more socially responsible agenda. These people, whom I refer to collectively as "Sustainability Inc.," believed that if companies committed to measuring and reporting publicly on their sustainability performance, four things would happen:

1. Individual companies' social, environmental and governance (ESG) performance would improve.

2. A link tying companies with better sustainability records to better equity returns would emerge.

3. Investors and consumers would reward companies with strong sustainability performance and put pressure on those that lagged.

4. Ways to measure social and environmental impact would become more rigorous, accurate and widely accepted.

A casual observer might think this approach is working. To some extent, they're right: The number of companies filing corporate social responsibility (CSR) reports that use the Global Reporting Initiative standards has increased a hundredfold in the past two decades. According to the Global Sustainable Investment Alliance, socially responsible investment has grown to more than $30 trillion. However, a closer look at the evidence suggests that the impact of the measurement and reporting movement has been oversold.

THE PROBLEMS WITH REPORTING

There's no doubt that attention to ESG issues can deliver better social, environmental and financial outcomes for individual companies. That said, corporate sustainability efforts have not made much difference for society or the planet. In addition, the reporting itself suffers from some very real problems.

LACK OF MANDATES AND AUDITING.

Most companies have complete discretion over what standard-setting body to follow and what information to include in their sustainability reports. Although 90% of the world's largest companies now produce CSR reports, a minority of them are validated by third parties. As a result, a lot of the data is misleading and incomplete.

SPECIOUS TARGETS.

According to a 2016 study that examined more than 40,000 CSR reports, less than 5 per cent of reporting companies made any mention of the ecological limits constraining economic growth. Even fewer stated that when developing their products, they integrated environmental goals that align with experts' understanding of planetary boundaries.

OPAQUE SUPPLY CHAINS.

Decisions made to chase low-cost labour have led to highly distributed supply chains where the producers of goods are often located nowhere near the end-users. Supply chains have become multitiered and contractors have increasingly outsourced to subcontractors; this has made traceability problematic.

COMPLEXITY.

Advances in technology (artificial intelligence, satellites, sensors, blockchain and so forth) have given companies new tools for measuring and monitoring their environmental impact. Yet reporting on vital sustainability metrics still has gaping holes.

CONFUSING INFORMATION.

Even for consumers who care about sustainability issues and are dogged in their pursuit of sustainability information, CSR reports are often bewildering. Unlike with temperature or calories, consumers have no intuitive reference point that helps them understand many measures of environmental impact.

INATTENTION TO DEVELOPING COUNTRIES.

In its push for reporting, Sustainability Inc. has focused primarily on publicly traded U.S. and European companies. However, the greatest increases in consumption, emissions and social impacts in the coming decades will occur in China, India and Africa.

THE BIG ISSUES WITH SUSTAINABLE INVESTING

Even if we assume that most investors care about these issues, it is not clear that their pressure can deliver real social and environmental progress. Here's why:

UNHELPFUL DEFINITIONS OF "SUSTAINABLE."

According to the Global Sustainable Investment Alliance, nearly two out of every three dollars classified as socially responsible investment are in "negative screen" funds — funds that qualify as sustainable because they exclude one or more categories of investments (say, tobacco or firearms). A 2020 study by Barclay's found no difference between the holdings of sustainable and traditional funds.

UNRELIABLE RATINGS.

John Elkington, a founding father of the sustainability movement, proposed the "triple bottom line" framework for reporting in 1994. Dozens of other frameworks have been advanced since then. But growth has not improved reliability. There are structural measurement and reporting problems because the data is voluntarily shared, largely unaudited and incomplete.

LACK OF COMPARABILITY.

It is nearly impossible to compare companies on the basis of ESG performance. It is sometimes difficult even to compare the performance of a single company from year to year because of changes in methodology or decisions to use different metrics or standards to measure the same thing.

CHALLENGES IN ASSESSING SUCCESS.

If one of the goals of socially responsible investing is to deliver positive social and environmental outcomes, how do we know if that investing is working? A recent study found little evidence that it is. According to the authors, the vast majority of ESG investment is allocated to mutual funds that either stay away from specific industries or factor ESG data into their decisions about which stocks to buy. Neither strategy was found to yield meaningful social or environmental outcomes.

DIFFICULTY OF SCALING UP

A small but fast-growing subsection of socially responsible investment — impact investing — is focused on addressing societal challenges. Here, too, there are issues. Not nearly enough capital is allocated to the impact investing category to address the challenges we face.

WHERE TO FOCUS

Sustainability Inc.'s focus on measurement and reporting has likely helped delay much-needed structural transformations. This is not to say that investors and companies can't make a difference. But if we are to bend the global emissions curve downward and address growing environmental and social challenges effectively, a more aggressive approach is needed. The following suggestions are places to begin.

MEASURE LESS, BETTER.

The current plethora of authorities and frameworks for ESG measurement is unwieldy, confusing and burdensome for companies. It's encouraging that five of the leading standard setters and measurement bodies are collaborating to streamline and harmonize standards for reporting.

MOBILIZE.

Attempts to self-regulate have delivered incremental gains that have been subsumed by business as usual and the unyielding pressure to grow. However, with mounting evidence that climate change is harmful and accelerating, grassroots global movements for action are making "good trouble."

CHANGE THE SYSTEM.

Executives and investors operate in keeping with the rules and incentives of the system. If their behaviour is to change, the rules that governments set and enforce also need to change.

GOING FORWARD, STABILITY

Prosperity requires that executive leaders advocate for structural changes that enable them to focus beyond the next quarter's numbers.

- This article was written for the Harvard Business Review by Kenneth Pucker, a senior lecturer at the Fletcher School at Tufts University and a lecturer at Boston University's Questrom School of Business.