The ESG dual mandate

If you find yourself questioning the famous proverb, “You can’t have your cake and eat it, too,” then you will appreciate one of the longstanding debates in impact investing. For years, people interested in investments advancing sustainable development have been told they must enjoy losing money. A fund seeking a positive impact on a social or environmental issue has a negative one on the wallet. You simply can’t have it both ways.

Or can you? A stroll down Constitution Avenue on the Mall in Washington, D.C., will take you past an institution that has been dealing with two objectives for decades. In 1977, Congress tasked the Federal Reserve with cultivating low inflation and a healthy labor market. Economists affectionately refer to it as the “dual mandate.” That’s as big a precedence as you can get.

The point here is that objectives often seem more oppositional than they are in practical application. That’s been seen in the rise of sustainable and impact investing. Structured differently and taking a more diverse approach than their predecessors, many of these investment strategies are seeking to fulfill a dual mandate to balance nonfinancial and financial goals alike. Faced with the false choice between investments yielding robust returns and those seeking to make a difference in the world, the answer is increasingly, “Why not both?”

The main argument against such a two-for-one is that financial connectivity and performance is quantifiable, while environmental or social impact is not. Qualitative assessments certainly play a large role in judging sustainability criteria, and the regulatory tides on either side of the Atlantic differ. But including relevant environmental, social and governance (ESG) knowledge into the decision-making process can be potent. Many a company with attractive valuations has floundered—or even foundered—due to self-inflicted ecological disasters, questionable human rights practices or inadequate internal controls. More and more, portfolio managers are looking for the symptoms of these material breakdowns with the same fervor they scour a balance sheet. But the application of material ESG information doesn’t have to be solely for prudent risk management. It also can serve specific client interest by identifying underappreciated investment opportunities in companies whose business models can potentially contribute to the real-world benefit of people and planet over the long-term.  

Opportunities for betterment can include secular themes such as circular economy, improving health, agriculture and water supply, financial inclusion, clean energy and education. Many of these megatrends align well with the United Nations Sustainable Development Goals (SDGs), which make them future-focused opportunities. Organizations such as the Global Impact Investing Network (GIIN) and others have built frameworks to help stakeholders determine what to consider with impact management.

Dual mandates tend to work better when they balance each other. Here the Fed is again an apt model. After slashing rates in part to support those unable to work when Covid-19 arrived in force, it has flipped to a tightening cycle to curb soaring inflation. The balancing act, while tricky in terms of timing and magnitude, helps prevent policymakers from egregious policy errors. The whole is indeed greater than the sum of its parts. A company that myopically considers only near-term profits can be blinded to serious long-term headwinds that an inclusion of ESG factors might unearth. Investors should no more ignore these than they should fight the Fed.