Responsible SRI

The Rise of Sustainability and Resilience

Quaker Earthquake

In 1758, a group of Quakers made a decision based on a fundamental principle that continues to be debated on Wall Street: they banned members from profiting from the slave trade. The argument wasn’t sentimental. It was that capitalists should not be indifferent to the consequences of their investments. In this case, it was obvious to most adherents at the time that profits generated from slavery should be forgone due to the harm they inflicted on the slave. However, how to apply a similar ethical framework to the myriad of other industries presents arguments impossible to resolve to this day, two hundred and sixty-seven years later. That being said, a new pragmatic approach is finally being built on capitalism’s own terms.

Socially minded investing works when it correctly prices risk that markets are ignoring. It fails when it substitutes values and virtue signaling for economics and fundamentals. For most of recent history, the field and its proponents did more of the latter than the former — and paid the price in terms of credibility, performance, and popular support. That era is ending. What is replacing it could be considered more cynical, but it is also more practical, rigorous, honest, and durable.

Welcome to the new paradigm.

A Longer History Than You Think

The impulse to align capital with conscience is not a product of 1960s Boomer activism. It dates back to a deeply devout Colonial America where religious and ethical principles imbued much of daily life. John Wesley, the founder of Methodism, laid out a systematic investment framework in his 1760 sermon “The Use of Money” that excluded industries harmful to workers and communities — tanning, chemicals, alcohol, weapons. The principle was distinct from charity. It was that profits earned through directly or indirectly harming others were illegitimate. This early exclusionary framework still exists today in the negative screening approach adopted by the socially responsible investment industry. At the end of this article, you can see the screening framework used by the leading index provider MSCI for its social investing products — it is essentially an updated version of Wesley’s list.

The modern social investment trend grew out of the rebellious social movements of the 1960s and 1970s. The Vietnam War, the Civil Rights movement, and a cascade of environmental disasters stoked a backlash against corporations that ignored the negative externalities of their operations. Students pressured university endowments to divest from defense contractors and companies that did business with South Africa’s apartheid regime. Shareholders forced Dow Chemical to stop producing napalm which deforested much of Vietnam. The creation of the EPA, the Clean Air Act, and the Clean Water Act gave government, for the first time, the power to attach a cost to corporate environmental damage. With the government’s backing, proponents of SRI had a stick to wield against companies that were unswayed by ethical arguments. The moment environmental risk became a liability on a balance sheet, corporate boards could no longer afford to ignore it.

Through the 1970s and 1980s, two investor communities merged under the SRI banner extending popular support for ethical investing: faith-based groups that had long excluded alcohol, gambling, tobacco, and weapons, and a new cohort aligned with the activist causes of the era. The 1990s absorbed the climate agenda under the banner of “sustainability.” The 2000s produced “best-in-class” and “double-bottom-line” investing as mainstream institutions began incorporating environmental, social, and governance (ESG) criteria to manage portfolio risk. The UN Principles for Responsible Investment (UNPRI) organized financial institutions to pledge to incorporate ESG issues into investment analysis, ownership policies, and decision-making.

The 2010s gave rise to “impact” investing, with its emphasis on direct, measurable interventions — poverty alleviation, healthcare access, renewable energy, regenerative agriculture. But it became more politicized when racial, ethnic, and sexual when corporate boards began to be judged through the prism of the racial, ethnic and sexual factors with the promotion of DEI (Diversity, Equity, and Inclusion). Concurrently, a focus on carbon emissions, often driven by mandates from major financial institutions such as BlackRock left many executives flummoxed by contradictions between capital providers and their respective markets. Reflective of the era’s emphasis on bold new approaches and focus on ideology over consumption, Germany decided in 2011 to shut down its nuclear power plants following the Fukushima incident putting into jeopardy its ability to provide its citizens with a stable supply of energy — an announcement called the swiftest change in political course since unification.

While each decade produced new vocabulary and the overall field of SRI expanded, the underlying tension remained constant: is this about values, or is this about risk and returns? The field never answered that question convincingly. It aligned simultaneously with certain political groups and governments willing to wave its banner and create mandates — establishing a structure that made the backlash inevitable.

The Rise — and Overreach — of SRI

The Pax World Fund, launched in 1971, was among the first mutual funds built explicitly on SRI principles. It marked the birth of an industry. The Domini 400 Social Index, launched in 1990, gave that industry its analytical backbone — the first capitalization-weighted benchmark tracking socially responsible investments, directly challenging the assumption that ethical screening required sacrificing returns. The index proved the thesis well enough to attract institutional capital, and institutional capital spawned an industry of ratings agencies, consultants, and product manufacturers eager to serve it.

For two decades, the field built steadily. Then it overreached. The years between 2019 and 2021 marked peak ESG — Larry Fink, the head of the world’s largest financial institution, BlackRock, declared climate change a financial risk and ESG a central investment consideration; UNPRI signatories exceeded 5,000 institutions; ESG fund launches hit all-time highs; assets under management (AUM) in ESG strategies exceeded $35 trillion by various measures. The language became evangelical. The commitments — Net Zero by 2050, portfolio decarbonization on aggressive timelines — were made by asset managers who had no clear mechanism for achieving them, premised on government policies that never materialized at the required pace. The assumptions proved wrong. The promises collapsed.

The backlash was swift and fierce and compounded by the surge in energy prices following Russia’s invasion of Ukraine. Suddenly governments were reactivated fossil fuel plants and even burning wood with scant regards for carbon emmissions. Republican-led US states began divesting from BlackRock and ESG managers, and accused them of abdicating their fiduciary duties to their clients. Fink himself abandoned the term ESG and other firms backed away from their stated goals for DEI and carbon emissions. In the US, anti-ESG became legislative.

Different regions also adopted different approaches to the promotion of an SRI agenda. Countries across Asia and the Middle East pursued their own economic interests while their domestic corporations operated largely free from the restrictive ESG criteria of their Western counterparts. Meanwhile, China aggressively pursued an industrial policy positioning it to become the dominant global supplier of clean energy solutions, while continuing to increase its own coal-powered electric capacity.

Remarkably, Europe, for its own reasons, accelerated in the opposite direction, deploying the most comprehensive sustainable finance regulatory framework in history through the Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive. The problem is European growth is moribund, debt and unemployment levels are high, and populist parties continue to gain across the continent. While Europe remains determined to leverage capital to fight climate change, its influence is waning, especially as more attractive opportunities exist outside of Europe. The result is a fundamental US-EU-Asia split in sustainable finance regulation that will define the investment landscape for the next decade.

The Global Sustainable Investment Alliance notes that governments and policy makers overplayed their hands in trying to regulate capital. They placed enormous expectations on private capital to finance the energy transition without creating the conditions — stable carbon pricing, long-term regulatory certainty, risk-adjusted return opportunities — that would make that capital flow. The impasse was built on mutual misunderstanding. It was also, to be direct, built on wishful thinking by an industry that confused cheerleading with economics and analysis.

Uncomfortable Contradictions

The ESG framework’s internal contradictions and lack of consistency were exposed not just by politics but by reality.