How Catholic Social Teachings Add to the ESG Portfolio
By Stephen Young, Caux Round Table for Moral Capitalism
Investing for ESG returns, or investing to generate ESG outcomes for the common good, comes in two forms. One is supported by what I call a weak theory and the other by a strong theory. Catholic Social Teachings provides guidance that can deliver the benefits of both.
The weak theory of ESG investing is the conventional one. It justifies an investment on ethical grounds. Like other forms of socially responsible investing, the weak theory version of ESG seeks to reduce harms and promote public goods both within companies and in the community at large.
This version of ESG focuses largely on a term from economics called “externalities” — the impacts of firms on their human and natural ecosystems. Traditional ESG investing seeks to encourage good externalities and minimize bad externalities by directing capital towards companies that provide relatively “better” outcomes. It also seeks to promote care for employees within the firm.
For those that are less familiar with impact investing, please see the following definition of ESG, which illuminates the types of externalities investors can be maximizing or avoiding.
The “E” in ESG refers to the environment as a stakeholder.
The “S” refers to customers, employees, suppliers, trust from investors, brand value, community and government regulation.
The “G” refers to employees, suppliers, trust from investors, brand value, community and government regulation. The “G” also embraces quality management of the “S”.
To me, the weak version of ESG seems to be just a different utility curve for some investors, a non-financial utility curve. An honorable one to be sure, and, like any good, worth pursuing.
In comparison, the strong version of ESG is more directly tied to measurable sources of financial value. This version considers a broad view of firm valuation that includes explicit consideration of company risks. If the risks are higher, then by necessity the valuation is lower.
In the strong version of ESG, risk is paramount. The question is: what risks should investors focus on, and how are they measured? The most telling factor is a company’s management of stakeholder relationships. Good management of stakeholder relationships lowers future risks, and in doing so, raises firm valuation. Consider the connection between the management of stakeholder relationships and value for the following companies: Boeing, We Work, Uber, General Motors (with the ignition switch malfunction), Volkswagen, and Goldman Sachs (after 2008).
Where the strong version of ESG meets the road, however, is in the selection of assessment criteria for measuring the risk-management of stakeholder relationships.
With respect to stakeholders, risk management is the flipside of ethics. Risk-management is a way of being responsible. Responsibility requires thoughtful risk taking. Being negligent, exploitative, uncaring, unstudied, emotional, subject to cognitive bias, is all being irresponsible. Not taking due care of stakeholders puts the financial future of any enterprise at greater risk.
Thus, here is the link to Catholic Social Teachings (CST) as it provides reliable and very ethical criteria for the management of stakeholder relationships. Ranking companies for performance according to CST provides a concrete basis for investing in some companies — the highly ranked ones — over others.
And, to have your cake and eat it too, the use of CST for assessment of companies combines the weak and the strong versions of ESG. Those who want to promote company alignment with CST in business and finance (the weak theory) can invest in a CST portfolio and at the same time favor companies with higher imputed fundamental current value (the strong theory).
There are four separate goals of CST. One is to recognize Human Dignity. A second is to empower those who live most closely with the consequences of decisions. The third is to promote mutual concern and interdependence. The fourth is to use material goods in a way which maximizes community benefit in addition to individual self-interest.
Assessing a company’s respect for Human Dignity examines its impacts on social factors and its governance, especially vis-à-vis its customers, employees, suppliers, and community.
Assessing a company’s commitment to Subsidiarity examines its governance of employees, its concern for customers, its engagement with its community.
Assessing a company’s commitment to Solidarity examines its concern for customer well-being, empowerment of its employees and its citizenship contributions to society.
Assessing a company’s commitment to what is called the “Universal Destination of Goods” examines its concern for shareholders and owners, customers, economic well-being of employees, contributions to economic and social development through innovation and fair pricing, and respect for the environment.
The Magni Catholic Values strategy offers a unique and very sophisticated approach to ESG investing. By integrating CST into our assessment criteria for investments, Magni uses a more robust framework for considering companies’ management of stakeholder relationships, as well as a more risk-oriented framework for considering ESG overall.