Could jettisoning the acronym in favor of a different term hold the potential to get back to basics on the practice of creating long-term value, which ignited this movement in the first place?
Yes, argues Alex Edmans, a professor of finance at London Business School, who has proposed the term “rational sustainability” to denote the practice that “considers all factors that create value, regardless of whether they fall under an ESG label.”
Rational sustainability, explains Edmans, focuses on outcomes. It ties sustainability to the specifics of a company’s core business, builds on evidence and recognizes “diminishing returns and trade-offs.”
- Pension funds, sovereign wealth funds and other investors who have a fiduciary duty to consider significant investment risks take a broad view of risk. “When you have a big portfolio, you are looking for the best returns, and you have to be mindful of the risks you’re facing in the economy,” Brad Lander, New York City’s comptroller, who terms his work responsible fiduciary investing, told my favorite local radio program last year. “That might be rising interest rates; that also, though, could be rising temperatures and seas because that has an impact not only on the city and on the planet, but on our portfolio.” Call it what you will, fiduciaries consider long-term risks in their decision-making.
- Responsible fiduciaries differ from investors who may invest for nonfinancial goals. Values-based investors aim to align their investments with their ethical or political values. Impact investors want their investments to generate measurable social or environmental benefits. Fiduciaries incorporate sustainability criteria to manage risk and enhance long-term return. All three types of investors, however, can be rational, provided they are transparent about nonfinancial goals and clear-eyed about the potential financial implications.
- Responsible fiduciaries have found that consideration of select sustainability factors – not all factors all the time — has enhanced long-term returns. The highest-rated companies by MSCI, for example, consistently outperformed the lowest-rated companies in both developed and emerging markets over the last decade on a risk-adjusted basis, even after controlling for region, size and sector (as well as throughout the COVID-19 pandemic and the onset of the Russia-Ukraine war). That’s not to suggest that such companies will continue to outperform; only that an approach which intentionally incorporates financially relevant, industry-specific risks has helped to identify companies with business practices that have generated superior investment return over the past decade.
As this suggests, the basic principle that investors and companies should consider any factor that could impact the creation of long-term value, regardless of label or acronym, lies at the core of sustainability. “Creating sustainable profits, companies, economies, and societies should be of interest to everyone, irrespective of their job title, their political persuasion, or their age,” Edmans writes.
Time will tell whether rational sustainability or some other term supplants ESG in the financial lexicon. But by focusing on the substance of how companies create value over time, Professor Edmans offers clarity for everyone who prizes both rationality and sustainability when it comes to investment decision-making.
*Edmans points out that he is not a marketing professor and had previously suggested “long-term value” or “intangible assets.” I am also not a marketing expert and would favor “intangible value,” which, incidentally, was the original name of MSCI ESG Ratings (“Intangible Value Assessments” or IVA).