New opinions are always suspected, and usually opposed, without any other reason but because they are not already common.1 – John Locke
All new ideas are abnormal before they are normal.
It is human nature to look to what is normal as a guide. And a strong justification is needed to feel comfortable in deviating from this guide.
The unspoken “normal” approach to investing consists of considering quantifiable financial metrics to determine the potential risk and return tradeoff of a particular investment. Investors then use these metrics to decide if the potential risk/return matches their desires.
To consider something that is non-quantifiable in an investment decision is understood to be “abnormal” and makes many people feel uncomfortable. After all, an important part of judging an investment’s performance comes from the ability to measure it, right? Therefore, incorporating abstract concepts like hunches, personal biases, or values into an investment portfolio can be seen as problematic by the broader investment community, which prefers “normalcy.”
In line with the recurring routine of abnormal disruptors impeding on the incumbents to be dubbed the new normal, the abnormal practice of incorporating personal values into an investment philosophy is now becoming mainstream.
Even though there are many categories, classifications, and labels for different types of investing that consider a person’s values—some with overlapping criteria, some with contradictory criteria—it is estimated that global growth in the overarching label of “sustainable investments” has exploded from $13.3T in 2012 to $30.7 in 2018 (see pie chart).2
Morningstar observed this trend in 2019 within the U.S. fund industry. The flows into sustainable U.S. mutual funds and ETFs alone nearly quadrupled from 2018 to 2019. Further, flows into these funds set a new quarterly record for Q1 of 2020, bringing in an estimated $10.5B, which tops the previous record quarter of just under $8B that was just set in Q4 of 2019 (see graph below).3
So, why are investors deviating from the normal?
We believe that there are three primary drivers fueling this shift. And investors are compelled—with varying weights of importance—by any combination of the three.
The accessibility and convenience that has accompanied the evolution of the investment industry has also brought about complexity. And, as is the case with many industries, consumers are recapturing the notion that a market that is designed to be driven by consumer demand requires educated and intentional consumers.
In the food industry, for example, consumers are becoming increasingly aware of and concerned with the supply chains that produce the food that they are eating. The fashion industry has also had to respond to the demand from their customers for more transparency surrounding how their products are produced.
And like consumers, investors have similar concerns about where their profits are coming from.
Being persons of integrity for these investors is more than just an attempt to signal to the world that they are seeking to live good lives; rather, they understand the innate longing within every human to be whole—to live a life consistent with their beliefs.
As a culture, we are becoming more conscious of injustices, exploitations, and abuses of power. It is only natural, then, to feel uneasy when we profit from anything that perpetuates these wrongdoings, anything that, in essence, contradicts our broader convictions.
Given the complexity of the vehicles that connect investors to their investments, investors have begun to demand more transparency from fund managers and advisors in an effort to seek integrity in an area that has traditionally fallen outside of the jurisdiction of their values.
History is littered with examples of investors impacting society. We’ve outlined several of these examples in more detail in our white paper, The Power of Investing: Promoting the Common Good. Modern investing, however, because it is mostly accessed in the public markets, has managed to obscure the impact investors can have on companies.
Thoughtful skepticism concerning whether or not investing in the public markets actually has an impact on society has been a topic among investors for decades. People familiar with the industry understand that when you buy a stock on the stock market, you are not doing business with the company directly, you are instead transacting with the person who currently owns the stock.
With this understanding, does an investor or fund manager that intentionally buys the stocks of companies that align with a certain set of values actually have an effect on what companies do and how they operate?
We believe the simple answer is yes, and there are two primary ways in which this happens:
First, investors have the ability to affect company decisions through dialogue and voting privileges. As a fund manager, Eventide actively engages with companies that it invests in to address business practices or other corporate activities that are impacting society.
In addition, shareholders have the right to vote on corporate matters such as the election of board members. Board members in turn have the responsibility of hiring and holding the CEO accountable for the operations of the business.
Second, the allocation of capital in the financial markets creates demand signals that companies respond to. It stands to reason that if investors choose to buy the stocks of companies that are demonstrating competency in running a successful business, companies will respond by making sure they continue to prioritize those characteristics that investors are demanding.
On the other hand, if investors respond negatively by avoiding a company’s stock when the company acts irresponsibly or makes near-sighted decisions to maximize short-term profits, companies will be incentivized to shy away from these types of behaviors.
One common misperception of values-based investing is that introducing any sort of ethics or values into the criteria for investment decision-making is dooming the profit potential of that investment. So, the thinking goes, “What if a company that is considered ‘unethical’ ends up being a hot stock, and I miss out on the opportunity to benefit from its success because of my moral standards?”
Broadly speaking, however, this fear of missing out due to having moral standards is fading. Leslie Norton, in her June 2020 Barron’s article, “Companies and Investors Heed the Call to Action,” candidly makes this point:
For many years, most investors argued that it was impossible to reconcile personal values with a successful investment portfolio. Decades of research, not to mention investment performance, have slowly eroded that notion.
Warren Buffet, not known for following the criteria of ESG or SRI, has also pointed out that there are very important intangible values that companies possess that can lead to long-term success.
In his 2019 shareholder letter, he lists “able and honest management” as the second of three investment criteria that he holds. And he describes the ideal directors of the companies in which he invests in this way:
At Berkshire, we will continue to look for business-savvy directors who are owner-oriented and arrive with a strong specific interest in our company. Thought and principles, not robot-like “process,” will guide their actions. In representing your interests, they will, of course, seek managers whose goals include delighting their customers, cherishing their associates and acting as good citizens of both their communities and our country. Those objectives are not new. They were the goals of able CEOs sixty years ago and remain so. Who would have it otherwise?
For Buffet, doing what is right and doing what is smart are perpetuating interests, not opponents of one another.
The increased flow of capital into investments that have a values-based criteria reflects the realization that people have deep desires and convictions that they feel should be practiced in areas of their lives. It also reflects a willingness on the part of investors to make an impact with their money while at the same time investing responsibly for the future.
In this light, values-based investing may not be as new and abnormal as much as it is timeless and intuitive.