Divesting: for what impact?

Sustainable finance is experiencing a period of spectacular growth and the role of finance is being questioned in an unprecedented manner. Among the environmental, social and governance (ESG) strategies used by responsible investors, the simplest, and undoubtedly the most popular, is that of excluding bad ESG performers – also referred to as divesting or exclusion. But, divesting for what impact?

Excluding bad performers would have two main objectives: the first is to alter business practices by depriving the firm of funding and reinforcing the stigmatisation of its current practices; the second is to reduce risk and improve portfolio performance.

Divestment however seems to miss these two objectives. Altering business practices by depriving the firm from funding appears to be most effective on primary markets, but only for certain firms that really rely on the investor’s capital. Altering business practices by stigmatizing bad firms is unlikely, given the historical responses of the targeted firms, using for instance greenwashing or stigma dilution techniques. As for the second objective, it seems that risk is indeed reduced but performance is not necessarily improved. Reprehensible firms are generally characterized by a higher cost of capital – hence higher financial returns for the investor- mostly because they are unpopular and could bear a higher risk. The overperformance of ESG exclusionary funds that we observed last year for instance is rather explained by a momentum effect, which by definition cannot persist indefinitely. This means that in the long term we should expect higher returns for bad ESG performers and lower returns for good ESG performers.

There would thus be a financial cost of being a responsible investor in the long term. This cost is partially offset for first movers, in the ESG strategy popularity phase. It is therefore not always possible to “do well while doing good”.

Find out more about the impacts of divestment below :