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The problem with traditional ESG

Traditional approaches to ESG investing are limited and fail to capture the most important factors that contribute to business success and outperformance in investment returns. This is the view of Harvard Business School faculty Michael Porter, George Serafeim and Mark Kramer as articulated in one of the most important articles on ESG in 2019: Where ESG Fails.

In this article, the authors argue that traditional approaches to ESG are limited by focusing on too many check-box metrics that are not central to a company’s success or failure. Also, ESG analysis is often siloed, conducted separately from financial analysis, and cut off from deeper analyses of competitive strategy and broader social considerations.

The authors present evidence that alpha is generated not by employing traditional ESG analyses (where risk aversion is the primary driver) but by investing in those companies that create “shared value” for both society and the company’s shareholders.

The academics argue that companies obtain a competitive edge when they are guided by a strong social impact strategy and drive financial results by addressing social issues. Also important to a company’s success is an awareness of those social and environmental forces that impact the business and through innovation adopting strategies to adapt and prosper.

"The purpose of investing is to create a virtuous cycle by allocating capital to those companies that create the greatest societal returns — both in business as usual and in improving the welfare of customers, employees, suppliers, and communities. This virtuous circle drives present returns as well as future growth and opportunity.”

This might seem like a grand idea or it might seem obvious – but it is the essence of Honeytree’s approach to investing.

Honeytree’s investment thesis is responsible growth, which means we focus our investment analysis on identifying companies where social impact is translated into economic value. In our analysis we assess how well defined and clearly communicated a company’s strategy is, what core values are demonstrated, its approach to inclusivity, and its relationship with employees. In essence, a company’s strategic thinking and culture help us understand how these considerations drive greater productivity, lead to more customer gratification, and generate financial return.

Enjoy this insightful article!

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