‘You can’t have impact and improve returns’

London Business School finance professor Alex Edmans says those new to the field 'might believe in false promises'

You cannot reduce the cost of capital and improve investor returns, London Business School finance professor Alex Edmans has said.

Speaking in an episode of the ESG Out Loud podcast, Edmans said despite “basic finance theory” suggesting that if you are having positive impact by reducing a company’s cost of capital, you must be reducing your return because the company’s cost of capital is the return to investors, many investors, finance professors and policymakers are still making this claim.

“This is not possible. And if you can only have one or the other, that’s fine. Just be honest about it. When I go and buy organic food, I do this because I think it’s good for society. I don’t think it’s good for my wallet, but that’s fine because my motivation is not a financial one, it’s an impact one.”

Acknowledging the similarities between his points on this matter and those of ex-BlackRock CIO for sustainable investing Tariq Fancy, Edmans said, “You can’t have both [impact and improving returns] but funds that claim they can are likely to get more investors than those that don’t.

“Sometimes you might not always be able to vote for every climate proposal because it’s going to be in violation of fiduciary duty to generating long-term returns. And so that more nuanced message is not going to be as popular as the message that you can always get everything. If people are new to the field, they might believe in the false promises.”

Clarity on terminology will help, Edmans said. “The phrase ESG investing is confusing. For some people, ESG investing is just investing, it’s a way of creating long-term financial returns. It’s not to save the world.

“And then people like Larry Fink have climate risk is investment risk. He says ESG is capitalism, it’s about creating financial value.

“Then there’s a separate reason for ESG, which is to create social value and to change the world, for example to encourage companies to decarbonise, change the mix of their workforce, even if this doesn’t improve returns.”

Edmans suggested instead using the phrases “intangible investing”, which uses intangible information but tries to create long-term returns; “impact investing”, which involves financial sacrifice; and “values-based investing”, where you can divest from sectors or companies you don’t like but realise you’re not depriving them of capital.

Edmans also discussed his background and drivers, his paper, Applying Economics – Not Gut Feel – To ESG, and why he hopes discussions around ESG investing will become like those on quarterly earnings, in the podcast episode, which you can listen to in full here.

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Natasha Turner

Natasha was global editor at ESG Clarity, part of Mark Allen Financial, and a financial journalist for seven years. She has been shortlisted for Story of the Year and Investment Journalist of the Year...