Powerful critiques of ESG are necessary if the sun is to rise over the next era of Sustainable Finance.
ESG continues to grow
The juggernaut of ESG continues unabated. According to Institutional Asset Manager, ESG equity funds accounted for 90 percent of equity fund inflows in July, and the Global Sustainable Investment Alliance’s recent Global Sustainable Investment Review reveals that Assets Under Management through ESG funds and approaches now total $35 trillion. This equals 36% of all professionally managed assets from the United States, Canada, Japan, Australasia and Europe.
As do its criticisms
And yet, ESG is increasingly coming under fire. Most notably, the former Chief Investment Officer for Sustainable Investing at BlackRock, Tariq Fancy, has issued multiple polemics on ESG in recent months. He is pushing the message that ESG investing is a game of smoke and mirrors which achieves little impact and obscures the need for structural change through government regulation.
He is not alone. Aswath Damadaran, Professor of Finance at Stern School of Business is quoted as saying “More than ever, I believe that ESG is not just a mistake that will cost companies and investors money, while making the world worse off, but that it creates more harm than good for society.” Similarly Ken Pucker in Institutional Investor wrote, “Investors are finally taking ESG investment seriously. But as currently practiced, most ESG investing delivers little to no social or environmental impact.”
These criticisms hold water
They are all correct. Take, for example, the $35 trillion number from GSIA. A recent Bloomberg article showed that $25 trillion of this is invested using ‘General Integration’ strategies, which require investors to consider ESG factors but not necessarily act upon them. Another portion attempts to select the best performers based on ESG ratings, but ESG ratings are in and of themselves subjective, and focus disproportionately on what is financially material to a company’s bottom line, rather than on how a company is impacting the world around it. A very small segment of the $35 trillion will be invested in strategies genuinely pursuing impact goals. These figures are therefore misleading.
ESG does not equal sustainable investing
We need to move past a common understanding of the ESG industry as this huge uniform giant pursuing the same goal, and recognise that it’s a lot more complicated than that. If we don’t, we risk thinking that we are on the right track, and not put the energy into making the industry fit for purpose through better regulation, and also, crucially, better and more nuanced and transparent data.
ESG has been essential in popularising the concept of sustainable investing, and incorporating ESG considerations into investment decisions is still important. It does not, however, equate to sustainable investing, and will not be enough to achieve the fundamental change needed to make our economy fit for purpose. Achieving this understanding that ESG is not fit for purpose anymore is an entirely necessary evolution if sustainable investing is to become a force that genuinely drives a more sustainable and socially just future.
This change requires increased and improved regulation and data
What we need to move forward requires regulation, and quality data to support it. We need more regulation to define terms - ‘What is ESG?’ (we believe that ESG means identifying risks and opportunities relevant to a company’s bottom line), ‘What is Impact Investing?’ (we believe that Impact Investing is investing in a way that achieving a social or environmental outcome comes before financial performance) ‘What is Sustainable Investing? (We believe that sustainable investing is a combination of these two strategies, which considers how ESG risks impact the long term sustainability of a company, as well as how the company impacts the long-term sustainability of the world.)
Within each of these, there is also a great degree of complexity that needs to be backed up by regulation and more transparency - What criteria need to be met to be classified as ‘ESG?’ - is it simply to consider ESG factors, or is it to select the Best-In-Class, and how would an investor define between the two? The same questions hold for sustainable investing, impact investing (and ethical, green and socially responsible investing for that matter). These questions lie within the remit of the regulators, but need to be supported by individuals like Tariq Fancy, and the industry as a whole.
From great headlines to meaningful outcomes
In essence, what we need is an increasingly nuanced approach which treats each separate strategic, thematic and sectoral approaches as what they are, separate, rather than lumping them all under an unrealistic and over-simplified understanding of ESG as a single thing. This is much harder, and makes for worse headlines - but it is realistic, and is what needs to happen. A good demonstration of this is that European sustainable investments shrank by $2 trillion between 2018 and 2020 as policymakers tightened the parameters for what can be considered a responsible investment, according to GSIA. This is not the uplifting stuff of great headlines, but it is a step closer to the truth.
At the heart of this lies transparency. None of the above will work if we can’t actually see what is being achieved. We will continue to live in a world of excessive claims of sustainability, without the proof to back it up.
This is where an organisation like Matter comes in. We are not an ESG ratings provider. We go beyond aggregated and subjective ratings, and look past financially material factors in an attempt to understand the real impact that a company has on people and planet, across almost 400 different themes and metrics. Data of this sort allows us not only to understand the shortcomings of the industry as it is, but facilitates the creation of nuanced, tailored strategies that both minimise harm and pursue focussed environmental or social outcomes.
This data allows those investors truly trying to understand the sustainability of their investments and pursue sustainability outcomes to do so, whilst also facilitating the adoption of regulation which requires higher labelling, reporting and disclosure standards on investors.
As an industry we should welcome the kind of criticism we are receiving. It is essential if we are to usher in an era of better regulation and standards, better data and transparency, and crucially, better outcomes for people and planet.