Sustainable Investing: Beliefs, Constraints, and the Limits of Impact

Sustainable investing is no longer niche. With trillions under management in funds labelled as sustainable, ES (Environmental and Social) performance has moved from the periphery to the centre of investment strategy—or so it seems.

But how much substance lies behind the sustainability label? And are portfolio managers genuinely trying to make a difference—or simply doing what’s required to tick the ESG box?

In our recent study, we surveyed over 500 equity portfolio managers from both sustainable and traditional funds with a balanced sample from the US, EU, and UK/rest of world. Our aim was to go and get under the skin of what’s really going on: What do fund managers believe about ES performance? What are they trying to achieve? And what should we expect from sustainable investing?

The results challenge many assumptions about sustainable investing and highlight uncomfortable truths about its likely real-world impact.

ES matters but is nothing special

How important is ES performance to portfolio managers?

The answer: not so much. Relative to five other drivers of company value, ES performance ranked a clear last place in importance amongst managers of both traditional and sustainable funds. Although this does not mean it is irrelevant in absolute terms – most portfolio managers believe that at least some dimensions of ES performance are material to value. So ES performance matters somewhat but is nothing special. 

Surprisingly, given the academic evidence to the contrary, most portfolio managers believe strong ES performance leads to better share price performance and that bad ES performance damages returns. Why do they believe this? Mostly not because good ES performance is intrinsically valuable, but because it is associated with other characteristics that drive returns: a well-run company will likely have good ES performance, and vice versa. 

Portfolio manager beliefs translate into action: 74% of sustainable investors and 51% of traditional investors consider ES performance when selecting stocks, because they believe it affects financial risk or returns. Few are seeking impact, with only a fifth of investors or fewer using stock selection to reward or penalise companies for their ES performance or to affect their cost of capital. 

Constraints Matter—And Not Just for Sustainable Funds

One of the most striking findings is the power of constraints in shaping investment decisions. Seventy-two percent of fund managers told us that ES constraints—be they fund mandates, firm policies, or client preferences—led them to make decisions they wouldn’t have made otherwise. For sustainable funds these constraints are the primary reason ES performance affects stock selection. But constraints aren’t limited to sustainable funds. Among traditional fund managers 62% faced constraints, mainly from firmwide policies or client wishes. These constraints can matter, with at least 38% and up to 70% of sustainable investors reporting that they resulted in lower returns.

Perversely, these constraints can actually reduce both financial returns and ES impact. Nearly a third of sustainable investors said they had to avoid holding ES laggards they might have improved through engagement. Constraints also led many to avoid companies that were ESG leaders in “dirty” sectors—precisely the kind of firms that may be best placed to lead a sustainable transition.

Constraints are simple and effective, but a blunt instrument.

Limited Appetite for Sacrifice

Only 27% of investors said they would tolerate any sacrifice in financial returns to achieve better ES outcomes. Even among funds marketed as sustainable, few are willing to tolerate even a single basis point of performance drag in the name of ES performance. Fiduciary duty is the most cited reason for this. The prevailing view is that if you're managing other people’s money, your job is to maximise their financial return—full stop.

Sustainable and Traditional Funds: More Similar Than Different

Sustainable and traditional funds are surprisingly similar in practice.

Both overwhelmingly prioritise financial performance and are unwilling to sacrifice returns in the name of ES performance. Both believe that ES performance is less financially material than many other factors but majorities of both do think that good ES performance is correlated with the good returns and bad with bad. Use of ES factors to inform stock selection and engagement is common across the board. 

For sure, constraints from mandates and firmwide policies are more prevalent for sustainable funds and have a bigger impact on returns. But constraints matter for traditional funds too. Constraints and beliefs do not map neatly along sustainable and traditional lines. Asset owners wanting portfolio managers who care about ES performance need to interrogate the manager beliefs as well as focussing on the mandate. 

What Should We Expect from Sustainable Investing?

Most investors aren’t trying to save the world. They’re trying to make money – subject to constraints. Both traditional and sustainable investors believe that companies on the whole invest the right amount in ES to maximise shareholder value. Few are prepared to sacrifice returns for better ES performance. So we shouldn’t expect the fund management industry to lead the charge in improving the ES performance of companies. 

If we want ES performance to align with returns more often, we need government policy to do the heavy lifting: pricing carbon, protecting human rights, and enforcing social norms. Because until doing good becomes consistently profitable, fiduciary duty and incentives within the investment chain will limit the impact of sustainable investing.

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Alex Edmans is Professor of Finance at LSE, a CEPR Research Fellow and an ECGI Research Member.

Tom Gosling is Professor in Practice in the Financial Markets Group at LSE

Dirk Jenter is Professor of Finance at LSE, a CEPR Research Fellow and an ECGI Research Member.

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