Investors have become increasingly aware of the importance of environmental, social and governance (ESG) issues while making investment decisions, and ESG topics have become priorities for leading securities regulators and stock exchanges. The history of ESG dates back centuries, but recent laws, mandatory disclosures and enforcement actions have made it much more than a webinar topic. According to a PwC survey, the asset and wealth management industry showed an unprecedented acceleration towards ESG investments in markets around the world, with eight in ten institutional investors responding that they plan to increase their allocations to ESG products over the next two years.
The most prevalent concerns discussed with respect to ESG fit into five categories:
ESG is subjective, and ESG performance is difficult to prove through measurement and comparison.
An ESG strategy can result in different outcomes depending on the practitioner and portfolio. There is good and bad to this subjectivity: the good lies in the ability of any private market participant to theoretically find an approach to ESG that is palatable and customizable to them, and the bad manifests itself in misaligned expectations and difficulty distinguishing between the ESG approaches of fund or asset managers and benchmarking those against one another.
ESG requires sacrificing returns and constitutes a breach of fiduciary duty.
Contrary to some beliefs, ESG does not require investors to sacrifice returns for the sake of creating positive social or environmental outcomes, a practice sometimes referred to as “accepting concessionary returns.” In fact, many consider ESG to facilitate the opposite by limiting downside risk. The association of ESG with concessionary returns likely arose in part because of the conflation of ESG and impact investing. This is because some—but not all—impact investors knowingly accept concessionary returns in order to achieve social or environmental goals. In contrast, investors using an ESG-aligned framework may not achieve market returns but tend not to do so intentionally.
ESG is redundant because it is already part of best practice.
In some ways, ESG appears to be a new framework for assessing alignment to old ideals: following the law, treating your employees fairly and not damaging the land on which your business operates, among others. However, there is more to ESG than that. ESG is also flexible enough to identify and assess new risks as they arise. For example, with the advent of artificial intelligence and machine learning, additional risks around the ethics of these technologies and how they impact stakeholders have made their way into ESG analysis. While the concept of business ethics has existed for decades, ESG frameworks help adapt this older ideal to modern business practices.
ESG as a whole distracts from other issues and areas of potential Impact.
This viewpoint touches on two problems sustainable investors have been confronted with as ESG has become more popular. First, ESG programs do not always allocate the most resources to the risks and opportunities that are most impactful to society. This is because ESG is predominantly concerned with how ESG factors influence company performance. Second, as ESG and impact investing have been conflated, impact investing has become politicized. Investors seeking socially and environmentally impactful investments have turned to ESG despite the fact that impact investing, more than ESG, helps a business or organization produce a social benefit to society.
ESG is mostly virtue signaling and rarely involves follow-through on the actions stated or implied by ESG practitioners.
Virtue signaling and greenwashing are one and the same, and both are heavily criticized by market participants. Just as not all ESG practitioners greenwash, not all ESG practitioners virtue signal, and to the extent that virtue signaling is often considered an empty claim, it is already widely recognized as problematic. Regulatory bodies have also become increasingly aware of the need for rules around the substantiation of sustainability-related claims of financial products. Geographies such as the European Union (EU) and United Kingdom (UK) are moving more quickly on this front, with the EU’s Sustainable Finance Action Plan and the UK’s Sustainability Disclosure Requirements, and the US’s Securities and Exchange Commission is looking to follow suit. As these regulations evolve, repercussions for virtue signaling and greenwashing will deter those behaviors.
Corporations must take a broader view of governance to survive. Even with a shareholder-centric approach, corporations cannot ignore the interest of employees, regulators and other key groups. A good ESG strategy includes sustainability factors — such as a company’s efforts toward reducing its carbon footprint, going green, encouraging diversity or introducing employee wellness programs. It also focuses on sustainability efforts that matter the most to a business and are the easiest to put into action. An ESG strategy paves the way for a company to gain investor confidence, earn customer loyalty, reduce operating costs, and improve both asset management and financial performance.