Mental Models to Surpass While Investing in ESG
There’s a pervasive notion that small steps toward sustainability are good enough. But when they don’t add up to meaningful large-scale outcomes, frustration ensues. Effort without returns makes people think that maybe there’s really no meaning to fighting for sustainability in the workplace.
Because of this, many people continue to believe that selecting a more sustainable future requires sacrificing economic development and profit. It’s only natural that we get stuck in this vicious cycle and start to deprioritize ESG investments, like capital costs for reducing energy use and paying livable wages, because they seem more like expenses than investments.
But what if we told you that ESG does pay off, and what it takes to unlock that is a shift in mentality? That’s easier said than done, but it can be done. It starts with recognizing inherent biases and beliefs about sustainability and reframing current mental models, i.e., the explanation of how we think something works in the real world. But before we get into that:
What is ESG investing?
Environmental, social, and governance (ESG) investments are for businesses that seek to improve the world in any large-scale way. The process is based on unbiased ratings and assessments that help us evaluate how well an organization performs on ESG performance and support them with our funding. Some categories to look out for when assessing an ESG investment include:
- Sustainability efforts and environmental impact
- Impact on everything related to society, including LGBTQIA+ equality, racial diversity, and inclusivity at senior levels, livable wages, effect on vulnerable communities
- Standard of governance, from diversity in leadership to strength of relationships and trust with stakeholders
Broadly, ESG focuses on how a business treats its stakeholders, including the environment, consumers, workers, and communities. Investing in ESG, in essence, means influencing positive changes in society by putting our money where our mouth is.
Biases and incorrect mental models affecting ESG investing
ESG investments are picking up speed but are still relatively new to large swathes of the population. That means many of us are susceptible to biases and incorrect mental models that lead us in the wrong direction. We’ve identified some of these mental models, so you can introspect, correct and invest sensibly in a better future for all.
Falling for perceived costs when we should look for the real costs
Let’s think small, for starters. When we buy a car, we think about how much it costs, the road tax, how expensive fuel is, and how much annual maintenance costs might be. These are tangible costs that we can calculate in a matter of minutes. However, there’s a real cost hiding behind all those numbers: the cost of all this plus what we’re getting for free from the environment, like air and water.
It’s the same for large-scale organizations, who can see the costs of setting up offices and factories, but often forget about the real cost of emitting carbon and pollutants into the air and water. So, when investors make decisions about ESG investments, it’s only natural that the returns aren’t impressive: they never factored in all the costs involved in the first place.
One way to do this is to impose shadow prices on these “externalities” so they can be added to measurement metrics. When investors get correct pricing signals on everything that is going to be affected by their decisions, they will have much more accurate data to use while planning ESG investments.
Relying on limited perspectives
A problem that arises from treating sustainability as one department’s responsibility instead of the whole organization is that it leads to limited perspectives. It’s human to have biases and be susceptible to groupthink; however, this can have dangerous repercussions when it comes to ESG investing. It makes it easier to fall back on tried-and-tested initiatives, like swapping paper cups for reusable mugs, when there is no healthy conflict in decision-making.
According to former CEO of Unilever Paul Polman and leading sustainability thinker Andrew Winston, the way to break this mental model is to flush out old and stale thinking. This can be done by inviting a diversity of voices into the boardroom: representatives from vulnerable groups, NGOs who have been critical of the organization’s past ESG work, and younger employees who have much more at stake.
By inviting this sort of friction, organizations can bring forth new and counter-perspectives that, in turn, lead to potential solutions.
Sustaining focus only on short-term benefits
It can be tempting to focus on low efforts that bring the highest returns in the shortest possible time. This is especially so because clean technology and sustainable practices are expensive to install, and which almost always is given up in favor of a cheaper option. However, the case with any new technology is that it starts expensive but becomes more normalized as more and more people subscribe to it. That’s the case with sustainable practices, too.
To reap the true benefits of ESG investing, organizations should broaden their view to include the long term. A few ways to stop being tempted by sticking with the short-term run are:
- Understanding which few rating indices are most important without chasing every single one of them
- Speaking to stakeholders directly to see where there’s potential value and directing ESG investing accordingly
- Ensuring the organization is agile enough to weather economic crises and come out robust and sustainable on the other side
Misunderstanding ESG factors that are critical to the local area
Surface-level research has many problems — one of them being data from one country or region that is mistakenly applied to another. Areas of the world that will increase in economic power warrant a different kind of investment than those that will be flooded if climate change goes unchecked, like Miami, FL, and Bangladesh. Using data from America to make European decisions is a sure-fire way to tank investments and nip any idea of profits in the bud.
Therefore, it is worth putting in the extra effort to find localized data in order to make more effective decisions. This is especially true if the organization is based only in one country or in different countries.
To combat investment losses to the potential tune of millions of dollars, it’s always best to research the major, nonlinear themes that are affecting society today in both a global and localized fashion.
Concentrating only on one or two industries in one’s portfolio
Here again, there’s the temptation to play it safe by investing in limited industries or sectors. However, it’s important to note that different industries weather economic, social, and climate change differently, so putting all your eggs in one basket won’t do.
To lessen the chance that bad performance in one area may wipe out your investment funds, it is crucial to have a variety of industries represented in your investments.
ESG investing is the way to go
Today’s investors are very much involved in building a future they would want to experience and would like to create for their children. As a result, they prefer to invest in companies that are leaders in advancing ESG initiatives rather than those that worsen or contribute to these issues. ESG assets are set to hit $53 trillion by 2025, which means it’s a great time to add each of our power to the mix and be the change we want to see!