Would you be interested in investing in companies that produce nuclear weapons? Or companies that damage the environment, pollute our seas or violate human rights? Or companies that have been related to corruption scandals? If your answer is “no”, unfortunately it is likely that you are investing in some way in these types of companies today.
How can we avoid this? The solution could be in your pension funds, given the global investments they make on your behalf. Companies with excellent certified behavior currently represent only between 20% and 45% of the total. The question for both policymakers and citizens is: would you be willing to invest in companies that avoid unacceptable behavior?
Many of us would be willing to sacrifice some return on our investments in order to contribute to environmental conservation, for trusting companies that are concerned about the impact on communities, and for supporting good business management. However, it seems that worrying about our future as a society is incompatible with the pursuit of personal financial well-being, because of the ingrained belief, for example, that we must choose between economic growth and environmental sustainability.
This is a false dichotomy. Being sustainable does not mean rejecting economic growth and financial well-being in any way. Sustainability, as stated in the 1987 Brundtland Report, is "to ensure that it meets the needs of the present without compromising the ability of future generations to meet their own needs".
One way to do this with a significant and immediate impact is to allow workers who are obliged to contribute to their pension fund to distribute their savings towards sustainable funds. In Chile, for instance, the current pension system allows all citizens to choose between five alternative funds with varying risk profiles, from the most conservative, in which the investments in equities are only 5% of the value of the fund, to the most aggressive, which can reach up to 80% in equity investments.
Given that financial and pension education in Chile is low, it can be a complex decision to make. In addition to reducing fund options, an easier, more committed and meaningful decision would be to offer the possibility to invest part or all of the savings in companies that behave better than their peers. This performance should be measured in terms of companies’ environmental (E), social (S) and governance (G) aspects. These are the so-called ESG criteria.
The traditional form of recognizing the "social responsibility" of companies is represented by the ideas of Milton Friedman in the 1970s, stating that the social responsibility of managers is “to conduct the business in accordance with their desires (the owners), which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom”. The downside of this argument is that it does not consider the so-called “negative externalities” that are the damaging impacts of industrial activities on third parties or the environment.
In contrast, Hart and Zingales in 2017 incorporated the possible negative externalities in their analysis, concluding that the welfare of the shareholders is not equivalent to maximizing the market value of the companies. Companies and asset managers must follow policies consistent with the preferences of their investors to maximize their well-being, which includes not only monetary aspects, but also priorities related to environment, democracy and social well-being, among others.
Investors voting on corporate policy is one way to achieve this. This is precisely what our proposal seeks: for citizens to express their well-being and sustainability convictions through their pension funds. In the case of Chile, Pension Fund Administrators (AFPs) could maintain the traditional five risk profile funds, but could also offer in parallel the same composition of funds with ESG certification.
No other measure has as much impact on sustainability and depends directly on a personal decision as investing in sustainable funds. According to the calculations made by the Nordea Bank's sustainable finance team, moving personal savings to sustainable funds can be 27 times more efficient in terms of improving your personal carbon footprint as eating less meat, using public transportation, reducing water use and air travel combined. It seems that the solution is within immediate reach of policymakers and later on, citizens.
This proposal would create at least two important incentives. First, it would push pension funds and other asset managers around the world to subscribe and incorporate responsible investments within their portfolios. Second, it would pressure companies to play a more prominent role in addressing critical challenges associated with the Sustainable Development Goals (SDGs), such as economic inclusion, closing gender gaps, and reducing climate change. Companies with a vision of the future already understand that performance in areas associated with ESG criteria affects long-term performance.
A reasonable question is whether you would have to sacrifice monetary returns in order to invest in ESG funds. The answer is no. According to one of the best-known and global ESG stock indices, the MSCI ACWI ESG, its returns between September 2007-2018 were 81%, compared to the standard MSCI ACWI index return of 70% over the same period. The same MSCI company has shown that companies with ESG profiles exhibit higher cash flows, lower idiosyncratic risk and higher valuations.
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Is there enough volume of ESG companies to be able to transfer those savings? The answer is yes. Investment in ESG companies is estimated at more than $20 trillion, or about a quarter of all professionally managed assets worldwide. Additionally, strong growth in sustainable assets is expected to be driven by global agreements in carbon emissions reductions, disinvestment in fossil fuels and a change in preferences, especially of women and millennials interested in investing in long-term sustainability factors.
Today, we have the opportunity to generate changes for a better future with the possibility of allocating part of our savings in pension funds to sustainable funds. Citizens can shape our future immediately, changing behavior and creating incentives for more companies to address what is important for the well-being of our current society and future generations.