The simple act of selling stock is not often thought of as affecting government, but in the case of apartheid-era South Africa, it helped to bring an end to it. The apartheid case is one of the earliest successes of a concept called “ESG” (Environmental, Social, and Governance) investing.
ESG funds and investors seek to promote a particular value or set of values that fall into the Environmental (like climate change), Social (like anti-apartheid), or Governance (like corporate board diversity) category. Let’s use a historical example of early ESG investing’s impact on apartheid.
ESG Investing and Apartheid
In the 1980s, the apartheid regime became particularly cruel. As a result, protests against South Africa’s government became more frequent and spread worldwide. College students in the U.S. and Europe demanded their universities’ endowments, which controlled billions of dollars, divest (sell) stocks and bonds that supported or made money in South Africa. (Two notable examples at the time were Barclays Bank and Royal Dutch Shell.)
At first the students were ignored, but in 1986, beginning with Hampshire College, over 150 universities, and then over 90 cities and states, took divestiture actions to varying degrees. Congress then passed the 1986 Anti-Apartheid Act. Barclays and Shell ceased doing business with South Africa. Others followed. As more and more companies pulled out of South Africa, the corrupt regime realized their choice was to either end apartheid or face economic isolation and ruin. The divestitures were not the only reason the regime folded, but they are credited with helping.
Much like a boycott seeks to make a statement with a spending wallet, ESG investing seeks to make a statement with an investing wallet.
ESG Investing Today
Estimates are that 2020 saw a tenfold increase in ESG investing compared to 2018, and more than double that of 2019. Headlines are producing many questions about what it is, how it works, and whether it’s worthwhile. “ESG” is a broad term that has no standard definition right now. Generally, it is a label applied to a process of either selecting companies or funds who meet criteria in one, two, or three of the ESG categories, or de-selecting those who don’t.
ESG in its early days was often called “SRI” (Socially-Responsible Investing) because it promoted a few ethical values in the social arena. Anti-apartheid was one example, but also there were anti-alcohol, anti-tobacco, or anti-firearm “filters” that were applied to investment strategies. The filters were often used for religious values reasons by Christian, Jewish, and Muslim organizations with large investment endowments. Rather than seeking to change society’s “sins” with their investing wallets, they were choosing not to participate in profiting from them.
Over time, mutual funds began forming that focused on the “E” – environmental values. For example, they might exclude fossil fuel companies or companies that did not meet certain pollution-control standards.
Other fund companies formed to focus on “G” – for example, by excluding companies that filled their boards with family members of the CEO.
ESG Exclusive vs. Inclusive Approaches
As the list of bothersome issues to put on the “excluded” list expanded, more ESG funds formed to take a more inclusive approach on positive issues. They might focus, for example, only on biotechnology companies working on the human genome. Or only on companies that met certain “green,” carbon-footprint standards. Or only on companies with a certain level of diversity on their boards.
In terms of issues most important to certain groups of investors, the list grew, and so did the number of investment funds catering to those groups.
ESG – Sacrificing Return for Values?
Until the 2010s, the mainstream financial world largely ignored ESG, assuming that exclusions for things like social and personal values were destined to depress returns. ESG investing became confused with charity, or sacrificing for a greater good.
Within the last decade, however, studies have shown that some ESG-focused investments actually outperformed their benchmarks and non-ESG peers. Understanding the reasons behind the outperformance instances is not yet clear. Guesses include that companies become less liable to lawsuits and liability when they take actions that benefit their communities and employees. They can keep more profits for shareholders and spend less on lawyers. The true reasoning is probably more complex than this, but nevertheless we now have data that says focusing on ESG doesn’t necessarily mean giving up higher potential returns.
DOL: No ESG for Everyday Employees
ESG made headlines in 2020 not only due to how much money was flowing into it, but also because the Department of Labor outlawed it as a fund choice in 401(k) plans. If the rule is sustained under the new administration, ESG investing will be accessible only to those who have investments outside of their employer retirement plan.
ESG – Brave New World
Navigating the ESG investing world can be confusing and tricky for at least four reasons. First, there are the different types and acronyms (SRI, Green investing, impact investing, are just a few). Second, there are over 30 documented ESG issues that investors want to address (environmental sustainability, employee rights, or board transparency are a few examples). Third, some of those issues can directly conflict with each other (in the extreme, for example, ExxonMobil is both a fossil fuels company and a company investing billions in fossil fuel alternatives). Fourth, sometimes it takes a mathematician to understand how, and whether, ESG goals are being achieved.
An important beginning is to figure out which values you most want to either include or exclude, and then do your research. Morningstar.com is one source that has many articles. Other resources are listed below.
Liz Weston’s column on the DOL rule: https://www.tampabay.com/news/business/2020/10/09/sustainable-investing-could-get-a-lot-harder/
or Jon Hale’s recent Morningstar article: https://www.morningstar.com/articles/1015649/3-momentous-events-highlight-the-impact-of-investing-in-2020