Does finance exist in a moral vacuum?
The industry remains divided.Over the last decade, Socially Responsible Investing, broadly defined as the integration of economic, social, and governance factors (ESG) into the investment process, has come to the forefront of conversation. Popular topics include: resource management, climate impact, pollution prevention, human rights, health and safety, product quality, board accountability, executive compensation, shareholder rights, and reporting and disclosure. Yes – everyone’s talking about it. But the debate endures as fund managers and financial experts try to ascertain the significance of ESG investing.Proponents: On one side of the spectrum there is a growing ensemble of investors asserting it is unacceptable for investment to be disconnected from society and environment. Proponents of ESG are mixed in their approach – some advocate for purely moral reasons, others for purely economic reasons, and a handful fall in-between, grasping onto both arguments.Skeptics: Critics of ESG contend that the sole purpose of investment is to maximize return. Critics assert that investment should be concerned with the bottom line, and those who want to “do good” should join a charity or drive solar cars. Furthermore, clients (at least thus far) have offered limited reward for managers who are integrating ESG into their process, leaving those who aren't skeptical.Let’s assume the argument for or against ESG is strictly about long-term performance.Consider William Sharpe’s Capital Asset Pricing Model. Though riddled with simplified assumptions, CAPM theory argues that, ceteris paribus, investors must consider the entire investible universe in order to achieve an optimal portfolio. Contracting this universe for ESG, or any idiosyncratic factor, is less than optimal. If a fund manager were to integrate ESG into the investment process, thereby excluding "irresponsible" companies, according to theory, he/she would not be able to achieve the highest return per unit of risk. Thus, in order for ESG-investing to result in equal or higher returns, proponents must contend that the benefits achieved from the remaining (less risky) companies in the universe outweigh the loss resulting from a less than optimal portfolio. And thus the argument ensues.My opinion? I remain on the quest to ascertain the extent to which ESG investing will affect the industry. Given a lack of hard evidence, it seems premature to make definitive conclusions about the widespread impact of ESG on performance. One thing is clear - a comprehensive collection of fund managers, consultants, clients, prospects, shareholders, and financial experts have focused their attention towards, at the very least, understanding ESG investing. The question lies in how strong the belief and implementation will become.