London Business School’s Edmans: Exclusion does not work with ESG

Tom Eckett

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Alex Edmans, Professor of Finance at London Business School and adviser to Research Affiliates, has said taking a holistic approach to environmental, social and governance (ESG) investing is the best method if investors want to see long term returns.

Speaking at a Research Affiliates event, Edmans (pictured) argued certain ESG strategies can improve investment returns however, it is important to ensure it does not become a “box ticking” exercise for the companies.

He gave the example of executive pay where in many circumstances ESG investors want there to be a more even share between CEO and worker pay.

Edmans stressed investors simply had a “pie splitting mentality” and, in fact, a responsible company is one which grows the pie so both the employees and executives’ benefit.

In too many strategies, he warned highly scoring ESG companies would be removed simply because it did not score well on one of the certain requirements while not taking into account the problem certain ESG factors may not be material for that company.

“Exclusion does not work with ESG,” Edmans continued. “A box ticking approach will not succeed as you penalise companies that perform badly on issues that are insignificant to that company.

"This approach considers one factor in isolation and could lead to an excellent company being excluded just because it does not tick a certain box."

Furthermore, an exclusion approach can lead to the removal of an entire industry. This can lead to underperformance if that industry performs well and it does not take into account companies that are best in class in ESG terms.

For example, Edmans highlighted the alcohol industry as one that is usually entirely removed from strategies. However, a company such as SAB Miller which has a range of CO2 reduction programmes is having a positive impact in that industry.

"There is no clear definition of ESG," Edmans said. "Evaluating whether a company is responsible is not a black-or-white thing that can be assessed by whether or not you tick a certain box, but involves evaluating the company as a whole and asking whether it creates a net benefit to society."

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