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Responsible investing is possible, but tricky without better fund managers and policy - Houston Chronicle

When choosing a place to put their clients’ money, a persistent dilemma for professional investors is whether they should seek the highest, short-term returns or consider the larger, longer impact on society.

The previous administration put the question front and center when the Securities and Exchange Commission considered banning fund managers from considering environmental, social and governance factors. The SEC’s argument was simple: your job is to make money, not pass moral judgments.

A new white paper from one of the world’s most influential financial law firms, though, reaches the exact opposite conclusion.

“Human well-being relies on the sustainability of key environmental and social systems. In some cases, that sustainability is under threat,” the report by attorneys at Freshfields Bruckhaus Deringer declared. “This is partly the result of economic activity and, if not addressed, will create risks to economic systems and all who rely on them.”

Such a simple statement of fact, yet a concept completely at odds with our “greed is good” approach to capitalism. No, this is not a call for a socialist revolution. The report reinforces a central tenet of capitalism that insists self-interested commercial activity should improve our world, not destroy it.

After all, Adam Smith emphasized that the invisible hand of the market economy works only within a functioning set of “laws and institutions” that provided a level playing field and guardrails against nihilism.

Capitalism’s excesses are apparent in the rising level of greenhouse gases in the atmosphere and continued reluctance to reduce emissions. They reveal themselves in the political deadlock that leaves citizens of advanced democracies radicalized. Growing inequities in wealth, income, housing and health care have millions of people calling for change.

Many of those people are major investors. Ranging from California’s public employee retirement system to the Ford Foundation, big institutions are under pressure to make investments that, at the very least, will not do additional harm to the environment or society.

Some examples of what “investing for sustainability impact” supporters avoid are fossil fuels, tobacco, gambling and snack foods. Others would also add defense, gunmakers and alcoholic beverage corporations. Many of these stocks offer high dividends, though, and professional investors would advise including a few of these in a diversified portfolio.

If we can agree that money rules the world, we must also agree that investing can reverse these worrying trends. The Freshfields Bruckhaus Deringer report investigates whether institutional investors may get choosier with their recommendations and not run afoul of their fiduciary responsibility to prioritize their clients’ profits.

Attorneys looked at 11 jurisdictions around the world, including the United States and the European Union. For the most part, they determined that fund managers could include ESG considerations when making investments.

The problem comes at the end of the year, when clients review how well their fund managers performed. Most will compare their portfolio to an index, such as the broad-based SP 500 Index. If a manager focused on sustainable investing comes up short, they can lose a client, or worse, end up in court accused of mismanaging the fund.

Ultimately, the dilemma of how to invest does not fall on fund managers but on clients and policymakers. Clients need to understand and accept that sustainable investing may not perform as well in the short term, and policymakers need to find ways to incentivize responsible funds.

“These issues need to be addressed by the relevant societies through a political process,” the report concludes. “It is not realistic to expect institutional investors to resolve them on their own.”

One way Congress can encourage responsible investing is to allow fund managers to consider the long-term impact on the larger economy of an investment. For example, coal mining stocks may look attractive, but the harm done by burning coal is so enormous that the government should allow managers to consider the sector un-investable because of the long-term danger to the economy.

The good news is that so many clients are demanding sustainable choices that corporations are changing their ways. In 2005, only 1 percent of executives mentioned ESG in their quarterly conference calls with investors. In 2021, the number rose to 19 percent, according to investing firm PIMCO, which manages $2.2 trillion in assets.

Today’s biggest challenge is determining what is sustainable and what is cheap talk to attract gullible investors. Establishing standards for ESG investments is one of the most important things the SEC can do for the public.

In a capitalist democracy, the average citizen has two ways to change the world. The most important is the ballot box, but the most impactful may be where you invest your savings.

Tomlinson writes commentary about business, economics and policy.

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