ESG Investing Has Gone Viral
The accelerating virality of ESG investing share a lot in common with the self-reinforcing network effects that drove social media platforms. They have effectively become pseudo-monopolies, and ESG investing will likely follow a similar path in essentially swallowing everything and becoming the de facto market. In other words, ESG investing will become just investing. It’s hard to imagine a world without social media now, and soon it will be just as hard to imagine a world where we invested without ESG principles at the center of the collective market’s investment decision-making process.
Capital = Social Media
Furthermore, capital’s conceptual anonymity and liquidity are similar to the forces that helped social media to scale. The core value proposition of social media is it is super easy to convince oneself into believing that it is a substitute for real action. This is not necessarily a bad thing, and it is absolutely necessary to lower the mental barriers so that they don’t suffer from the Paradox of Choice where they end up doing nothing. Extraordinary convenience and ease of use drive adoption curves and critical mass.
As it relates to ESG, a conscious decision to allocate capital to serve a more enlightened vision of the future is a relatively easy way to express one’s forward-thinking progressive self-image. A cynic could characterize this as a form of personal greenwashing and there is an element of truth here. Similar to social media, the ramifications of the actions of individuals can have a profound impact on critical conversations on a global collective basis.
The big difference however is that capital has a direct impact on resource allocation by companies and the knock-on impact on corporate strategies and behavior – a stinging, hurtful, self-righteous tweet might not have the same impact. Sure, companies might apologize for an insensitive ad campaign or even pull products from the market; however, probably nothing structural will likely change. This is more of a public relations exercise. Capital however has a powerful multiplier effect and is already having an impact on the cost of capital, and thus the impact of ESG on the global economy feels more permanent than not, and it appears that we have hit an asymptote on the curve.
Fund Flows to ESG Are Real – Regulatory Impact Will Accelerate It
This change in capital allocation is being driven be two opposite ends of the spectrum – individual investors who are choosing ESG mutual funds over conventional funds as a personal expression of moral values, and sovereign/pension funds that are expressing the wishes of their stakeholders and exercising their fiduciary duty. Fund flows to sustainable funds are accelerating and have already reached $1.2 trillion according to Morningstar. So, at the margin, ESG investing has already achieved majority mainstream status. This will accelerate further when bodies such as the EU start imposing a taxonomy on how companies should disclose ESG factors. And to boot, sustainable funds have outperformed traditional equity funds and their benchmarks the past several years.
Critics would argue that ESG investing is a fad and not rooted in hard-nosed economics that demands efficient allocation of capital. Just like social media, one can debate whether it is the dog or the tail relative to the real world; however, one cannot debate that social media has changed the world – for better or worse – probably worse. This is absolutely the case for ESG investing – one can debate whether this is good or bad economically speaking, and it is certain that the intensity of this conversation will only heat up over time. However, one cannot debate that ESG is changing the world and also how capital is being priced and will be allocated.
Capitalism: A Medium for Social Change?
We do not buy into the view that we will all of a sudden have a moral awakening that will result in each stakeholder voluntarily making economic and social sacrifices to achieve a better collective result. This is almost laughable and absurd. We humans just aren’t wired that way. However, it is this ease of making capital allocation shifts that are the motions of butterfly wings that will ultimately result in a hurricane halfway across the world. And the irony is that a very traditional capitalistic mechanism like capital allocation will likely drive corporate behavioral change that will have a greater material social and environmental impact than more altruistic stakeholder groups.
We will still fly planes, we will still manufacture plastic, we will waste a lot of food, and some of us will probably hoard gas ranges to cook in underground kitchens even if they are grandfathered in this hypothetical home appliance dystopian near future world where people who cook with gas are socially shamed but not persecuted. This massive socioeconomic change will be messy, and it will not be linear. The irony here is that the very nature of capital lends itself very well as the medium for social change, which is objectively weird.
Price Discovery of Social Value – Have Our Cake and Eating it Too
When the world starts rewarding companies for more than solely profit maximization, the price of assets and how they are valued will also change. It is an elegant and efficient mechanism to enact the necessary changes we need in our economy. We sort of can have our cake and eat it too; however, this will likely be achieved without our full understanding of it – a nod to the invisible hand – and with a lot of help from regulators who understand capital markets and capitalism, and everyday people making individual choices on a collective basis. Hopefully, all this will be better than the net impact of social media. A low hurdle indeed, but we’ll cross our fingers anyway.