The psychology of ESG and sustainability investing

Summary: How do you (and your clients) manage the often conflicting emotions that derive from making decisions related to sustainability and investing? We discuss three psychological challenges that are helpful to know about when advising on ESG and sustainability investing: The Riverbed Effect, Comfort Blankets and The lions in the Mind.

Why this is important: Attempting to drive change while we are informed by the states of mind that have been predominant in the past will lead to misguided action, confusion and frustration. On the flipside- by better understanding our drivers and emotions we can learn how to recalibrate our mindsets to make more effective decisions, build trusted partnerships with clients and drive the sustainable changes necessary for our collective futures.

The big theme: The thing with sustainability transitions is that whilst there is a starting point, there is no end point. The world is a continually changing place and we are continually transitioning. It's a series of steps. The transition is by definition about enabling change and that means engaging with people. We see this as one of the key underdeveloped areas in sustainable investing.

Why clients struggle to make decisions and how you can help

One of the biggest real-world challenges for everyone involved with sustainability and finance/investing is managing the complex emotions involved. The group most on the front line in this are the advisers. Many are unsure how to engage with clients’ worries, suspicions or resistance to ESG and sustainable investments. They want to make the debate understandable but can struggle with over simplifying often complex issues. And it can be hard to silence the siren voices that promise easy and painless solutions. Plus, adding sustainability into the mix is difficult in a world that has historically focused on risk, reward and diversification. While being informed is important, the answer is not just more facts. We all need to help our clients adopt a new mindset, as well as evolve our own.

Why clients struggle to make decisions and how you can help

At this unprecedented period in history, knowing how our minds work and how to deliberately recalibrate the way we make financial decisions will be critical. The need for different ways of thinking and investing in order to safeguard our climate, nature & societies is evident. Attempting to drive change while we are informed by the same states of mind that have been predominant in the past will lead to insufficient incremental advances, as pointed out by Christiana Figueres and Tom Rivett-Carnac, architects of the Paris Agreement in their book The Future We Choose. Changing the way we think is difficult and confusing.

It is a deeply personal endeavour, requiring us to question our existing assumptions and beliefs. And as financial advisers in sustainable investing, helping your clients to expand their mindsets and evolve their way of making decisions is an even greater, albeit critical challenge!

We want to help you with this, by sharing some of our insights into the psychology of decision-making. We will share with you some of the main psychological barriers that limit, distort or confuse clients’ judgments when engaging with ESG and sustainability issues, so that you can begin to address these and help them make better informed decisions.

Lost in the ESG Maze

We have been witnessing close up the ongoing struggles advisers and asset managers face when seeking to inform clients on ESG investments. There has been many a meeting where clients seem stuck in old patterns of thought, finding it difficult to make decisions about their ESG strategy. They don’t know where to start, they don’t know what they are looking for or, more fundamentally, they say they just don’t understand.

Given all of the practical and psychological challenges involved no wonder so many clients are struggling!

One issue we want to address upfront is what is meant by ESG investing. The phrase has become widely used without really being clearly defined. As a result, the topic has created massive amounts of press and social media comment, often in the process generating more heat than light.

This approach has found favour among many in the investing community, who treat it largely as an extension of their normal investment case process of examining all of the risks and opportunities that could impact a companies value.

We find this perspective to be overly narrow. As well as generating a fair financial return, many investors also want to see their capital being used "to do good". This requires us to bring in the concept of double materiality, which adds into the analysis the impact of an investment on the wider world (we have written a long blog on this topic, which you can find here).

In that spirit, let’s imagine sustainable investing from the perspective of a seasoned client who is new to this field: this investor is used to their tried and tested approach to succeeding, most probably based on a track record focused solely on generating superior risk weighted returns. It’s what’s familiar, what generates confidence.

Now venturing into the new territory of ESG and sustainability, they are encountering few proven ways of succeeding (as of yet), high levels of complexity, and many moving parts, with (as we discuss above) significant contention as to what this approach to investing should even entail, how it should be measured and what you should do with the data when you have collected it.

Clients really do want to get to grips with this – but they often lack the tools

They know that they need to get to grips with sustainability topics, and may well also feel motivated to do so. But they are baffled as to what they need to do and may lack trust in the process. They are likely being guided through this unpredictable maze by new and unfamiliar experts, many of whom have different career profiles to them- with backgrounds in academia, science, and not for profits.

And because of the unprecedented nature of sustainable investing these advisors often do not yet have a successful track record in investing. As a result, this investor may not trust that these experts truly understand the issues they are grappling with nor do they believe that will they be able to help them make the best investment decisions.

Conversations with clients being advised on ESG and sustainability issues can therefore result in confusion, resistance or misunderstandings.

So what can be done to improve clients’ decision-making abilities?

Historically guidance has often been to take emotions out of investing decisions. This is physically impossible, as you may well have experienced as you grapple with worry, excitement or the roller coaster of wavering confidence levels when deciding how to invest. Humans are constantly pounded by emotions. And if the influence of these is ignored, they shape our judgements and actions in unpredictable ways that we can’t control. Like doing your weekly shop on a hungry stomach.

On the flip side, if you get to grips with your own psychology and that of your clients you can use this to your advantage as well as theirs, helping them to make better investment decisions.

The Riverbed Effect: Getting stuck in well-established patterns of thinking, finding it mentally strenuous or impossible to look at issues from new perspectives.

Comfort Blankets: Selective interpretation of information, actions or situations, in order for us to feel better about ourselves. This often comes at the cost of factual accuracy.

The Lions in the Mind: Feeling emotionally (threatened), too stressed to think clearly or logically anymore.

Once you are aware of those challenges and how to spot them you can build up your strategies to manage them. We’ve outlined some initial ones in this article, but you will hopefully find many more, based on your experience and those of others.

Let’s start with the Riverbed effect

This is a term coined by the neurologist Richard Burton: old habits run deep. It takes time and effort to change them. Our decision-making habits are physically embedded in our brain, by neurological pathways that are strengthened every time they are used. Imagine it like the gradual formation of a riverbed: the more we repeat the same patterns of thinking the harder it is to change them.

Over the course of our lives our accumulation of experiences, information, relationships has shaped a unique riverbed in each of our minds, causing our thinking to flow in certain directions with greater ease. This produces feelings of certainty and confidence about opinions, actions, views of the world.

Conversely it also means it takes more effort and feels less intuitive when engaging with distinctly new perspectives, making decisions based on fundamentally different priorities. That is one of the reasons why getting our heads around ESG and sustainable investing can generate confusion as well as an instinct to dismiss it, as its novel approach can go against the grain of traditional investment strategies. If clients seem stuck in old patterns of thinking, keep repeating the same points over and over again, mentally struggling to see or talk about issues from a different perspective, the Riverbed Effect may be at play.

So what to do about the Riverbed Effect?

Normalise not knowing Flag to your clients that intellectual (and emotional) discomfort is to be expected when making new kinds of investment decisions, because of the Riverbed Effect. Discomfort often leads to better decision making, as it is a sign that we are expanding our viewpoint. And developing new patterns of thinking takes time. So be patient and encourage them to be patient.

Position your role as a friendly dissenter:as an adviser to them you will not only inform but also bring in dissenting views. Your aim is to not only provide them with new perspectives & facts to create new channels of thinking but also to challenge them, to expand their thinking. By flagging this from the outset they will expect it, less likely to be taken aback when you probe their reasoning. We will share some suggestions for how you can further help clients expand the horizons of their decision making in a future article.

Comfort Blankets

Whereas the Riverbed Effect is more likely to limit our thinking Comfort Blankets is more likely to distort our thinking, by compelling us to be selective about what information we take in and how we interpret it. The underlying priority, when Comfort Blankets is at play is to reassure ourselves and minimise our anxiety. This tends to be at the cost of factual accuracy.

Emotions run high when it comes to the planet and our finances, it fuels individuals’ instinct to seek out metaphorical comfort blankets: to comfort ourselves by only finding evidence that proves what we want to believe. It’s something we all do, to a greater or lesser extent. We are often pretty adept at ignoring things that might undermine the beliefs we use to frame our world.

It is what writer & entrepreneur Margaret Heffernan refers to in her book “Wilful Blindness: Why We Ignore the Obvious at our Peril ”, turning a blind eye to information we don’t want to see so that we can keep feeling good about our actions (and our finances). As the US writer Upton Sinclair noted: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

Wilful Blindness is a particularly high risk in sustainable investing, where we hold two potentially conflicting personal goals at the same time- wanting to do what’s right for the planet, whilst maximising financial return for the individual. Emotional tension generated from trying to reconcile these two goals tends to influence what information people seek out, pay attention to and how they interpret it.

In these circumstances information isn’t rejected because it is false but because it is uncomfortable, because it causes cognitive dissonance. Unaddressed cognitive dissonance, that feeling we get when we know that our actions don’t align to our personal goals and beliefs, causes angst. A desire to minimise this angst narrows the range of information we pay attention to when making investment decisions and how we engage with it, which in turn impacts on our ability to make decisions based on sound logic.

Human instinct is often to look for an easy solution

In the case of ESG and sustainability, this easy solution is presented as a “Win Win” for the planet as well as our finances. We so want to believe that contributing to the greater good and maximising our own gains can be achieved at the same time that we are susceptible to green wishing. A key example of green wishing is the prevalent belief in this sector is that good ESG companies outperform others, because they are good ESG companies, when in fact research suggests it is other factors that drive this. This is an approach some advisers also follow: don’t worry about the conflict between your values and your financial returns, you can have both – just by investing in high ESG scoring companies.

An alternative reaction is to minimise the tension by rejecting one of the conflicting beliefs- i.e. Green Bashing: ESG is broken, just focus on maximising return on investments because climate change isn’t that important or we are doomed, it’s too late anyway.

As is all too familiar to us recently, turning a blind to information we don’t want to see leads to decisions based on erroneous facts, ultimately resulting in investments that will be damaging to the environment, financially, or both. If your clients (or fellow advisers) seem to almost exclusively be engaging with or accepting information that backs up their existing beliefs, if they also vigorously defend it, rapidly and instinctively pushing back against differing views, then Comfort Blanket instincts may be at play.

What to do about comfort blankets?

Help clients figure out their own inner conflicts, blind spots & blockers when it comes to sustainable investing. We are most likely to absorb new insights when we find our own answers, as you may well know from experience! This is because when we come up with new insights it generates an “aha” response in our brain and releases endorphins, making us feel good about what we have learnt. On the flip side, people directly pointing out contradictions or blind spots in what we say tends to trigger a defensive mindset.

You can use simple frameworks to help them figure out where there may be contradictions, green wishing or green bashing in their thinking. This is not just about providing new information, educating clients. It's about helping them to build new frameworks to find their own answers. This requires us to help them figure out what outcomes they actually want to deliver, as well as understand which trade-offs they will need to make decisions about . We shall share some frameworks and approaches to help with this process in a future article.

Be patient with clients, none of us like our comfort blankets being pulled off in one go.

You can also ask them questions to help them find out what is holding them back from making new kinds of investment decisions. Try to understand what they need, what do they fear, what are their doubts, and their hopes? The more time you take to get to know them, the more open-minded interest you demonstrate in their perspectives, the more likely they are to understand their blockers and be willing to move out of their comfort blankets.

The lions in the mind

The lions in our mind start roaring when we feel threatened in social situations. When we feel like others are putting us down, that they are making decisions that are worryingly unpredictable, that they are controlling the situation, can’t be trusted or are outright treating us unfairly.

If the perceived threat is big enough, for example when we are in an outright argument or feel infuriated by what the other person is saying, our mind and body will be triggered into a stressed state. Our heart will start beating a faster, our palms may start sweating, our jaw clenching, our feet tapping. Stressor hormones will be released to prepare us for battle-oxygen and glucose levels in our brain are reduced and our attention narrows right down. It is what the psychologist Dr Daniel Goleman calls an Amygdala Hijack, introduced in his book Emotional Intelligence: Why It Can Matter More Than IQ

In this state we are less able to take in new or complicated information, we are far more likely to make generalisations, jump to incorrect conclusions and become fixated with defending ourselves against the perceived social threats. We can tell we aren’t thinking straight but can’t seem to get ourselves out of this defensive loop. Does this pattern sound familiar, in your clients and in your own lives?

Dr Goleman explain there are three signs of a hijack:

“One is that the person has a very strong emotional reaction. It might be anger, fear or going to numb. It’s something that doesn’t help in the situation. The second is that it’s very sudden. It takes over their reactions. They are surprised by it, as are those around them. Third is that it leads them to do something that doesn’t work, that isn’t helpful.”

A model based on neuroscience research called SCARF by Dr David Rock can help you try and figure out what might have triggered this reaction. And what to do to help calm them down.

The SCARF model five common factors that can activate a reward or threat response in social situations. The SCARF model involves five domains of human social experience: status, certainty, autonomy, relatedness, and fairness.

1. Status – our relative importance to others.

2. Certainty – our ability to predict the future.

3. Autonomy – our sense of control over events.

4. Relatedness –how much we feel we trust others, how connected we feel to them

5. Fairness – how fair we perceive the exchanges between people to be.

What to do about the lions in the mind?

Spot clients’ triggers & adapt your approach

If you notice clients are starting to feel defensive, protecting themselves against what you are saying or doing, you can use this framework to try and spot what might be triggering them.

Do they feel like you are pushing them to do things your way? Do they feel judged by you, or that you aren’t interested in their opinions, don’t value their experience? Do they find what you are advising is too vague, too risky? Or do they worry you may be trying to take advantage of the situation, that you are not treating them fairly? If the answer to any of these is yes then you know it’s time for you to change your approach.

Examples of how you can then minimise the Triggers include: If you think their Status is being threatened focus in more on aspects of their experience or knowledge that you value. If you think they are looking for more Certainty ask them more about what is it about the plans that worries them? Then consider how to share relevant information in a more logical and practical manner. If they feel like you are impacting on their Autonomy stop pushing them. Instead of trying to win them over with arguments take a pause. Let them re-initiate the conversation and go back to asking them questions, to find out what their hopes, fears and ideas are.

The same goes for Relatedness- they need to feel like they can trust you, that they understand you and you understand them. Take the time to get to know each other before diving in with the facts. The more they trust and feel connected to you the more open they will be to the information you have to share. Fairness is often about making sure you communicate decisions in a clear and transparent way, so that people feel like they have all the necessary facts, that they are not being taken advantage of.

Thinking about your own state of mind

As you have been reading this article it may have brought up memories of working with clients. It may also have got you thinking about your own state of mind. This too is helpful. The more you understand your own hopes, fears, ways of seeing the world and triggers the more you can decide how to respond to different situations.

Getting to know your own psychology will make you more aware of how you are likely to interact with different clients, how they are likely to respond to you and how you can adapt your approach to strengthen your collaboration with them. The stronger the collaboration and sense of trust the more likely you are to help them make better decisions.

Finally, knowing the strengths and limitations of your own knowledge will help build trust with your clients. The systemic nature of sustainability issues requires a systemic approach. Reach out for expertise in the fields that you lack- both by broadening your networks and by diversifying your sources of information.

At the Sustainable Investor we seek to help you with this, by providing you with perspectives from across finance, markets, psychology, human rights and environmental law.

Please read: important legal stuff.