Millenials are notoriously skeptical of capitalism. In one Harvard survey, 51% of 18-29 year-olds said they were opposed to capitalism versus just 42% who supported it. Yet by and large we are not taking our avocado toast and moving to Sweden.
Instead, skepticism of capitalism and its harbingers has nudged banks and asset managers to sell products that create a return to society as a whole. Investments that meet targets for environmental, social, or governance standards — collectively referred to as “ESG” — now comprise roughly one quarter of the $88 trillion worth of assets managed globally. These investments can include anything from a corporate bond to build a solar energy farm to stock in a company known to be actively seeking more women on its board of directors.
Yet lack of transparency and fuzzy industry standards mean that determining the real impact of ESG investment is incredibly difficult, and allows investors and corporations wide latitude for determining for themselves what types of investment qualify as “ESG.”
The most common technique banks and financial institutions use is a screen. AIG’s ESG dividend fund selects what companies they invest in based upon a composite score of four criteria: total return, capital appreciation, current income, and a criteria for environmental, social, and corporate governance standards. This excludes or limits investments in companies like Phillip-Morris, Exxon-Mobil or BP, whose products have deleterious impacts on society.
Sometimes, these screens have a political dimension. In the wake of the Parkland shooting, the world’s largest asset manager BlackRock — with $8 Trillion in assets under management — unveiled a set of portfolios that would exclude gun manufacturers and retailers, including Walmart and Dick’s.
Citigroup and Visa placed hard limits on gun sales to anyone using its credit cards while other financial titans like JPMorgan, BofA, and Visa increased scrutiny on gun retailers’ sales to potentially dangerous individuals. The maturation and growing number of ESG funds in principle allows clients to have more freedom to match their personal values to what companies they choose to invest in.
By implicitly putting guns in the same category as tobacco and fossil fuels, Citigroup and Visa are sending the political message that gun purchases are so harmful to society that they are willing to take a financial hit by shunning these sales. This puts pressure on gun manufacturers to further justify investment in their products to their creditors, eating up time and profits, and shifting the gun debate in favor of control.
In an era of strong consumer activism and government oversight, firms face pressure to put their capital where their public outreach is. In 2013 Kao Corp, a Japanese cosmetics firm, sold a product that inadvertently caused white spots to develop on the skin. Instead of litigation, the company reached settlements with nearly 18,000 victims of the error and implemented strict quality standards at 95% of its plants. Kao Corp was designated an “industry leader” in corporate governance by Sustainalytics, an ESG ratings firm, making it more likely to receive financing from ESG-rated funds.
Bankers have a strong incentive to hold companies accountable to governance or social standards. Companies’ stock prices often plunge after high-profile scandals and incur loss of business from angry customers and hefty costs from fines and litigation fees.
Shareholders have an incentive to avoid investing in scandal-prone companies too. BP’s share price is still below its pre-Deepwater Horizon peak, and many folks who bought Volkswagen stock in the year before its 2015 emissions scandal, still haven’t earned a return nearly 3 years later. This creates an incentive for shareholders to pressure companies into improving their disclosure rules.
Remington — the 200-year-old manufacturer of the infamous AR-15 was forced to shutter its doors after rounds of litigation by Sandy Hook victims and other gun companies like Ruger have laid off hundreds of workers. For banks that want to protect themselves against this kind of risk, the best strategy is to demand of firms higher standards of transparency, controls against fraud and bad behavior, and internal accountability when things go wrong.
Deep-pocketed pension funds, normally ponderous and overly-sensitive to risk and volatility, are also leveraging their access to vast amounts of money to incentivize companies to pursue higher standards. CalPERS — California’s state employee pension scheme with nearly $350 Billion assets under management — has long experienced pressure from teachers and state employees to divest from undesirable products, including oil, coal, and guns. Since pressure to forego profits for social responsibility comes from shareholders themselves (teachers), the forces that usually resist pursuing social impact are minimized.
The pension fund recently created an executive position under the organization’s Investment Office responsible for integrating ESG factors into the core of its investment decisions. Prior to its creation of an ESG officer position, CalPERS had faced scrutiny from its shareholders — California public employees — for its investments in oil and gas companies, having used its leverage Creating this position sends a signal to investors to start thinking about how their portfolios meet targets other than profit maximization and allows the organization to allocate more resources to investigating whether certain projects or companies meet ESG standards.
Skeptical of the capitalist profit motive, millennials’ demand that banks increase their stake in the social impact of their investments has revitalized competition and innovation in the citadel of capitalism — the financial industry.
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