Tuesdays with Travis is a collection of monthly interviews with our data science lead, Travis Korte, that explores the complexities of expressing values through data.
To divest or invest? For those seeking to build more sustainable portfolios, that’s often the question. But there’s no one answer, and there are tradeoffs with both. In this second installment of Tuesdays With Travis, we discuss different approaches to, and costly assumptions about, screening out “bad” companies and investing in those we deem “good.”
Check out the key takeaways at the end and be sure to leave a comment if you’d like to address specific topics going forward. Comments have been edited and condensed.
Sustainable investing is often associated with its divestment roots, where investors screen out so-called “bad” companies in their portfolios. How have approaches evolved?
For a lot of people, the most intuitive way to approach sustainable investing is by creating a list of companies to divest from that they find objectionable. That’s traditionally how a lot of responsible investing was done, with people trying to express certain values.
Today the motivations are more diverse. It’s still common to start with divestment, but some clients also try to maximize their impact by supporting companies that are doing things they think are positive. And there’s a third group of investors that isn’t consciously coming at it from a moral direction, but they’re trying to reduce their risk, and a lot of time that risk is associated with the reputational, legislative, or other indirect impacts of bad behavior.
When should one divest versus invest? Is one approach more effective than the other in certain circumstances?
You can start from either stance, but it’s important that you don’t do either in a vacuum. It’s the strangest thing to me when I look at most so-called “sustainable” ETFs. They’re supposed to be promoting companies doing good things like investing in renewables, but when you actually look at the companies, you have all these flags for child labor, toxic waste spills, major fraud cases, all kinds of problems. I don’t get it. If these ETFs want to say a company is “doing well” on some sustainability issue, wouldn’t it make sense to look into what harms they might be responsible for as well? Investment in renewables is great, but it shouldn’t be a “get out of jail free” card, not least because we don’t want companies thinking they can buy their way out of fundamentally unsustainable business models with a little cosmetic renewables investment. You have to have a broader accounting of the negative and positive impacts so you don’t get hoodwinked like this.
The opposite approach, which is only divestment with no sense of investment, is also tricky. I understand the moral motivation where you don’t want exposure to any energy companies, for example, and I share the intuition. The way most energy is produced and the incentive structures energy companies operate in are totally broken. But if you divest from the whole energy sector, regardless of behavior or performance within that sector, I’m not sure you get to say you’re divesting from these broken systems; it’s more like you’re divesting from the concept of energy as expressed in public markets. You’re effectively abstaining, and giving up your voice in deciding what the right direction should be. You’re preemptively excluding alternative approaches, companies that might do better in the future, or new entrants who might challenge the status quo. As an ESG strategy, divesting without investing is like not voting. You’re free to do it, I guess, but I’m not sure how you spin it as this high-minded, moral act.
A better approach is to combine investment and divestment. First, you remove the companies creating the most negative impacts in the areas you care about. Then, out of the remaining options, you reward the companies that are responsible for the positive impacts you want to see. This way, you’re not letting companies off the hook for a little strategic good behavior, but you still get to have a voice in the direction you want to see things going.
Let’s play devil’s advocate here. If I’m an individual investor and I divest from a company, there are probably many others willing to buy it. In that way, is divesting more symbolic than consequential?
I would take issue with the idea that you can split out “symbolic” effects from real effects. One of the purposes of making a sustainability commitment, of making any ethical decision, is in some sense to try and convince others to make that same decision. As norms change around what it means to make a good investment, these so-called “symbolic” commitments begin to change real behavior. Over time, as you draw attention to problems at a company, you may reduce the number of those “others willing to buy it.” So we’re really trying to facilitate the development of these better norms with our tools.
Even aside from norms, though, sustainable investing is also a means of personal expression. A lot of people can’t live with the fact that they own interests in companies that don’t align with their values. Even if nobody ever knows you’ve divested from some company doing some bad things, there may still be an intrinsic, moral value for you in taking that action. That’s ok too, and we want to be able to support that.
And even if you don’t feel particularly motivated in either of these ways, you might at least recognize that companies prone to controversies and bad behavior tend to lose money. We’ve had Boeing flagged for product safety since late 2018, and investors who incorporated product safety into their portfolios avoided not only the moral discomfort of owning part of the Lion Air crash, but also the drop in Boeing’s stock price that followed. The market seems to think a lot of sustainability issues are material, so at a minimum you might want to take that into account.
What are the common missteps when making the decision to invest or divest? What would you encourage investors to think through?
We caution against divesting from entire industries or sectors for the reasons we just discussed, mainly that you silence your own voice and exclude yourself from potential improvements. But there’s also the reality that you’ll instantly incur tracking error. You can’t toss out industries left and right and still expect to resemble the benchmark. You don’t have to be the most disciplined investor to see that excessive exclusion introduces risk, and that risk directly affects your ability to have future impacts.
When an investor cares about large, multi-faceted issues such as climate change or poverty, isolating certain causes to divest from or invest in could get messy quickly. Is there a better approach?
There’s an implicit assertion being made by the more traditional wing of the sustainable investment community that you can separate out the good from bad, or separate one cause from another. You’re interested in improving poverty but you don’t care about climate change? That’s fine, they say, we can do that. Here’s our “anti-poverty ETF”: it doesn’t look at emissions at all.
The trouble with this approach is that the world is much more complicated than that. A lot of the problems facing the world are interrelated in clearly observable ways. A lot of the worst impacts of climate change, for example, are going to be felt most in the poorest parts of the world. You can try to foster economic development all you want, but that’s not going to reduce the likelihood of a hurricane. Your weapons and tobacco screens aren’t going to do much about a famine. Climate change exerts – and will increasingly exert – a causal influence on who’s in poverty, so you’re not going to be able to address one without simultaneously addressing the other.
A lot of sustainability topics are clearly inseparable in this way, but I still see people all the time trying to create these little topic silos. Our approach is much more holistic. We’re less interested in trying to carve the market into moral tranches. We prefer to start with an impact we’re trying to achieve and then look at the spectrum of companies contributing to it or detracting from it in different ways. Then we remove the worst and promote the best. That’s it.
- While divesting and investing each have their purpose, investors achieve the greatest potential for sustainability impact by combining both strategies. Just investing in “good” companies can be tricky because while a business may “do well” on carbon emissions, for example, they could be fraught with terrible other practices, such as poor governance. Just divesting from “bad” companies ignores the potential improvements an industry can make, and silences an investor’s ability to voice their opinion.
- Be wary of divesting from entire industries. Doing so not only deprives investors from a sector’s future improvements, but can also incur costly tracking error.
- Thinking of companies as purely 'good' or 'bad' is too simplistic. Sustainable investors contribute more to their criteria of choice by choosing an impact and considering the spectrum of companies that contribute or detract from that goal.