Professor Charlie X Cai answers questions from Class of 2020 graduate Nachilila Kaluba
Charlie X Cai (Professor of Finance at ULMS) has recently written about sustainable finance and the implication of the current changing economic environment on investment strategies. He has published a book titled: The Experts and The Evidence: A Practical Guide to Stock Investing (its companion website can be found here). His research also explores the impact of technology, such as machine learning, on financial markets and understanding mutual fund investments.
Class of 2020 graduate, Nachilila Kaluba (BSc Computer Science with Software Development) now works as a Product Manager - Analyst at BlackRock, the global asset manager and technology provider.
Nachilila had some thought-provoking questions for Charlie…
Nachilila: Most of us Millennials/Gen Z are trying to live as sustainably as possible, however, our powers combined aren’t likely to be enough to avert the impending global crises we face. Companies are now trying to put their money where their mouth is on this topic. How can we effectively invest in companies that genuinely value sustainability? Especially since most sustainability-oriented companies aren’t publicly traded. What can we do to help the good, value-oriented companies over those who greenwash themselves?
Charlie: Thanks for the question Nachilila. It touches on the core issue of how to support sustainable growth at different levels of the economic ecosystem. You are right that we can influence businesses both as an investor and as a customer, which are also interconnected. The growth of the private sustainable business can be accelerated by bank and venture capital finance. As long as consumers make conscious choices of where and what to buy, this will feed into the business model of entrepreneurs and the investment decisions of investors.
For example, a recent report by McKinsey shows that Gen Z’s increasing demand for sustainable food systems has begun to see changes in various business landscapes including food cycling, alternative proteins and agricultural advancements. The investment in sustainability-themed start-ups has also grown significantly in recent years. Therefore, the power of consumers’ choices in accelerating the transition cannot be underestimated.
However, as you point out, business greenwashing can cloud the decision of consumers and especially investors as they may not have first-hand experience of the product and services which the company offers. In publicly listed companies, there is hope that the market collectively seems to be able to do the sorting of the good from the bad correctly from a valuation point of view.
For example, in a recent study on greenwashing in Corporate Social Responsibility (CSR) reporting assurance, we show that in general, investors in the financial market can differentiate companies with genuine commitment to CSR from those who opportunistically pretend that they care. In the private market, certifications such as those by B Corp, again not perfect, will help enforce the standard and improve decision-making to some degree. In Liverpool, we have 2030hub, the world’s first UN Local2030 Hub, which was built around the 17 UN Sustainable Development Goals and B Corp to support local business sustainability transformation.
Overall, the sustainable business transformation will need efforts from all levels. As consumers and investors, our choices will contribute to this path to sustainability and there are governments, organisations and businesses to provide help and support at all different levels. But the matching of these supports is not frictionless and needs everyone to be actively engaged and contribute to this development.
Nachilila: How can Environmental, Social and Governance (ESG) data that's currently being onboarded at massive scale by asset managers/financial advisors be improved to ensure portfolio managers are actually using this data to make real impact?
Charlie: This question highlights two key challenges in ESG investing. First, do we agree on what defines Sustainability/CSR/ESG and can we measure them with confidence? Second, can investors’ financial decisions make a real impact on a company’s ethics and operation? If the answer to both of these questions is yes then we should be confident that the data used by fund managers to direct their investment should have a real impact on business.
For the first question, it is challenging and evolving. As I quoted Peter Drucker in my recent blog on the Role of Business and Finance Professionals in the Sustainable Revolution: “If you can't measure it, you can't manage it.” The UN sustainable development goal provides an excellent framework for generating and collecting data to monitor progress. Lee (2021) from MSCI Inc. points out that a single ESG score or rating typically does not reflect both social value and financial materiality demands. She summarises four broad categories of ESG data sources from existing studies: company disclosures, media, alternative data sources, and modelled data. Among these, company disclosures are the most developed and standardised.
This type of data is the base of most of the existing ESG scores. Nevertheless, alternative data, such as supply chains, have been collected more frequently in recent times and used to guide investment decisions (Chapter 8, Investwithstyle.org - Book Resources). The market of ESG data will continue to evolve from both the demand and supply sides to meet multiple purposes. Investors need to be aware of which aspect of sustainability they care about and look for and demand the measures for their decision-making.
For the second question, the short answer is yes and financial investment would play an important role in the sustainable business transition. This message has been reinforced in The COP26 summit with the initiatives such as the Glasgow Financial Alliance for Net Zero led by Mark Carney. Through a commitment like this, reporting and measuring portfolio alignment would provide effective monitoring of the commitment to sustainability by the financial sector. Over 4,500 companies, including financial companies, have joined the ‘Race to Zero’ campaign through over 20 business alliances (Who's in Race to Zero? | UNFCCC).
These are not limited to large listed companies. For example, among these, there is also an SME climate hub in the UK. Guided by relevant data, investors and asset holders can not only punish those who are slow in this sustainability transition by removing their financial investment and hence increasing the cost of capital for those businesses but more importantly, they can also direct their investment into an innovative business that is promising to accelerate the transition. For some investors, they prefer to take a more direct approach. The most acute examples of real impact are from the ESG activist investors (How ESG Shareholder Activism Can Help Spur Change, theimpactinvestor.com).
Therefore, the key to answering your question is more transparent disclosure that is in line with different sustainable goals. This information will enable investors to direct their investment to make a real impact and show that they do care about and contribute to the overall sustainability transition.