The growth of sustainable investing is welcome news to those who believe a more conscious allocation of capital can cure society’s pains. A few years ago, sustainable investments were niche products. Now, almost every retail investing outlet offers a wide range of financial products marketed as sustainable. The increasing desire of investors to contribute to solving the world’s challenges is among the key drivers behind the trend. Accordingly, sellers of a large proportion of sustainable investing products make explicit claims of positive impact.

Truthiness abounds these days. The validity of sellers’ claims is less clear, however, for reasons ranging from inherent limitations in tracking consequences, to the real-world impact of investment decisions in generally efficient financial markets, to the vagueness and ambiguity of many claims, to, shall we say, cynical approaches to marketing. Start with the inherent difficulty with calculating the real-world impact of virtually any investment in the first place.

Capital for All That Ails

The Sustainable Development Goals (SDGs) are about as global a list of social and environmental issues as you’ll find. The SDGs include 17 development goals the United Nations has set for 2030 — for example, ending hunger and ensuring universal access to clean water, as well as mobilizing thorough measures to fight climate change. Moreover, the targets are ambitious, and reaching them will not be cheap. The UN estimates that every year until 2030, around $2.5 trillion in additional investment will be needed.

That sounds like a daunting figure. However, the Global Sustainable Investing Alliance recently estimated that almost $4 trillion is currently flowing annually into sustainable investments per year — much more than the annual financing required to reach the SDGs. So, why haven’t we solved the world’s problems yet?

Behind the Curtain

In a recent paper, my co-authors and I concluded that the current impact of sustainable investments is rather modest. There are two key insights into what impact means that help to explain why.

First, impact is the change that investors cause above what would happen anyhow. Having impact means that an action (in this case, an investment) results in real change — for example, a reduction in greenhouse gas emissions. It is crucial to think about what would have happened without that investment. Would greenhouse gas emissions have decreased as much (perhaps driven by market forces alone) regardless of the investment?

Second, an investor’s impact is not same as the impact of companies in the investor’s portfolio. Rather, it is the change in companies’ impact driven by the investment. It feels right to invest in companies that have an impact, but their impact is not your impact; distinguishing investor impact from company impact is critical.

Company impact is the effect a company’s activities have on people and the planet — for example, by selling products that reduce greenhouse gas emissions. Investor impact is the change in company impact that is caused by an investor — for example, by enabling a company to sell more products that reduce global greenhouse gas emissions.

Unfortunately, investor impact and company impact are often conflated. Consider one self-proclaimed “impact mutual fund” that invests in public companies that contribute to the SDGs. One of the fund’s top holdings is Gilead Sciences, a large pharmaceutical company that develops and produces drugs for severe diseases such as HIV. Arguably, the company has a positive impact on Good Health and Well-Being (SDG #3). The number of HIV patients treated with the drugs produced by Gilead Sciences can be used as a proxy of company impact. The more difficult question relates to investor impact: What effect does an investment in the fund have on Gilead Sciences?

If I invest in the fund, do more HIV-positive patients receive treatment? According to our research, this seems unlikely: buying stock in a company of this size is not going to have a significant effect on its cost of capital or its ability to deliver life-saving drugs.

Three Ways Investors Do Matter

Our research shows that there are three fundamentally different ways of how investors can affect companies. In short, investors can support the growth of impactful young companies, use their influence to improve established companies or influence public agenda setting by signaling their values.

1. Support impactful young companies. Investors can make a difference by allocating capital to companies that contribute to solving the world’s problems but whose growth (in contrast to, say, Gilead’s) is limited by access to external financing. For example, investing in a startup that has found a way to make solar panels more efficient could have a big impact if the venture is struggling to raise the capital it needs to scale. Of course, such investments are not easy to find, and can be risky. But that is the heart of the matter: if a company already has easy access to the capital market at reasonable cost, which is usually the case with large, established companies, an additional offer of capital is unlikely to affect its growth.

2. Encourage change in established companies. Investors can become active owners and use their voice as shareholders to convince companies to improve their business practices. A common approach is to enter into direct dialogue with top management. To this end, it may be more promising to target companies that have a lot of room to improve rather than current sustainability champions.

For example, after a shareholder engagement campaign, the Chinese oil major Sinopec introduced measures leading to a dramatic reduction in methane leakage. While the oil produced by Sinopec still makes a sizable contribution to climate change, the reduction of emissions caused by this reduction in leakage of this super-potent greenhouse gas is substantial.

Alternatively, investors can encourage change by excluding companies that breach widely accepted norms — for example, companies that are involved in human rights violations. If a broad coalition of investors act together, it can incentivize companies to improve — for example, by introducing strict policies to uphold human rights in their operations and those of their suppliers. As for active ownership, it is crucial to aim for verifiable changes that companies can implement at a reasonable cost. This will not cause a revolution. But many small improvements sum up on a global scale.

3. Influence public agenda setting by signaling values. A prominent example here is the coal divestment movement. Simply excluding coal stocks from a personal portfolio has no measurable impact. It will primarily result in a reallocation of coal stocks to investors who do not look beyond narrow self-interest. (And there are many of them.) As long as coal extraction remains a profitable business, shares will be largely stable in value, and coal extraction will continue.

However, if prominent investors are vocal about their decision to boycott coal, this can influence the public discourse — for example, on the question of whether the government should halt tax breaks to coal companies. This may give the necessary cover to politicians and regulators to withdraw support from politically active coal interests. The political dimension is essential; investment products that merely refrain from investing in coal stocks are not really contributing to the fight.

The Real Levers of Change

So, where is the aforementioned $4 trillion going? The vast bulk is allocated either to products that integrate environmental, social and governance (so-called ESG) data into their investment process in public equity markets — primarily to optimize financial performance — or in products that exclude specific industries, mainly tobacco and weapons. Our research suggests there is little evidence that these two product types have a relevant impact.

For sustainable investing to make a vital contribution to solving the world’s problems, the focus needs to shift toward mechanisms that have a significant impact potential. More investments need to go to effective young companies that need capital to grow and develop solutions. Here, venture capital, private equity and private debt can play a crucial role.

Given the limited ability of most investors to bear the risks associated with early-stage, illiquid investments, the majority of sustainable investments will stay with established companies in public markets. In these markets, there is a vast potential to expand active ownership and conduct-based exclusions that encourage companies to adopt sustainable business practices.

Investors can play a crucial role in solving social problems in general and sustainability problems specifically. But the answer is not feel-good investments in established companies with virtuous track records. It’s in investments that otherwise wouldn’t happen — and in challenging asset managers to use their muscle to deliver real change.