Debunking the myth of socially responsible investing

Can capitalism and social idealism converge? A critical mass of investors seem to be convinced that the answer is yes. A sprawling ecosystem has sprung up around "socially responsible investing," also known as ESG (environmental, social, and governance). This investment strategy encompasses a wide variety of asset classes and instruments with a common mandate: punishing bad actors and rewarding good—or, at least, less bad—ones using the conscientious allocation of capital.

According to a 2022 report from HSBC Global Research, the ESG thesis accounts for more than $30 trillion in assets under management, about one-quarter of the worldwide total.

But a new book by Brad Swanson, adjunct professor of finance at the Costello College of Business at George Mason University, argues that this industry-unto-itself rests on a false premise. Profit vs. Progress: Why Socially Responsible Investment Doesn't Work and How to Fix It (MIT Press) draws upon Swanson's unlikely career trajectory, which traverses the disparate worlds of journalism, international diplomacy, high finance—and, finally, impact investing, where he helped head up a firm whose portfolio spanned 70 countries.

"Around the year 2000, I became a fund manager investing in the equity of microfinance lenders," Swanson says, referring to finance companies that make small business loans to poor families shunned by the formal banking sector. "I began to really understand the dynamics of the business. We seemed to be having a day-to-day positive impact on our clients, but their lives weren't really changing significantly. They borrowed, and then they would borrow again, and again. So I started doing some research, and found that there really isn't an academic consensus that microfinance has a material impact on alleviating poverty. And I went from there to start questioning other aspects of socially responsible investing."

Swanson's book aims to debunk what he sees as the industry's foundational myth—the idea that ethical investing, if done properly, will match or outperform market-level returns. The need to deliver on this promise has led the industry to redefine ESG in terms that few would recognize as "socially responsible."

The book describes how asset managers (and the ESG indices, such as Sustainalytics and MSCI, on which they rely) focus on risk management rather than social or environmental impact. As a result, fossil fuels, tobacco, and other so-called "dirty" businesses are favored by ESG funds, because their activities aren't perceived to jeopardize profits—an apparent inversion of investors' good intentions.

"ESG funds are nothing but market funds with an ESG label," Swanson argues. "It's a complete mis-selling and completely neutral in terms of its effect on social development."

Swanson's critiques are not confined to ESG funds. His book also makes sharp yet nuanced appraisals of microfinance (as mentioned above) and green bonds. The latter, he asserts, suffer from essentially the same ruinous compromises as ESG funds, with issuers obligated to deliver yields on par with purely commercially-oriented bonds and little accountability as to how the proceeds are ultimately used.

In contrast, Swanson points to pure impact funds, which invest in "companies with explicit social missions. They're much smaller, they're privately owned, and they are less profitable because they have the social mission as their raison d'etre."

However, he fears that the integrity of impact investing is currently under threat from mainstream private equity players that are crowding into the space, bringing with them a modus operandi that prioritizes maximal returns and impatient exits.

"They're going to pump too much money in on the wrong premises, and we're going to see impact now becoming corrupted," Swanson warns.

As Swanson sees it, the overarching problem is that socially responsible investing attempts to force markets to accomplish something they were never designed to do. The answer to civilizational crises like climate change must start with governments, not capitalism. "The only solution is not to continue throwing money at companies, but to put our focus in the legislative arena and to try to change the rules so that we can allow markets to compete efficiently, but with a higher level of social performance," Swanson says.

As an example, Swanson lauds cap-and-trade systems such as California's, where governments set limits on pollutants and distribute a finite amount of pollution permission slips to companies.

"Cap-and-trade, to me, is the ideal example of how you can harness market forces in a way that does not at all restrict profit-making, or the dynamism of markets, but results in a huge social good—net zero—at the end of the process," he says.

More information:
mitpressbookstore.mit.edu/book/9780262051590

Provided by George Mason University