September 27, 2022

Under fire from all sides, ESG's contradictions reveal its true identity

For some, ESG does too much for the environment, for others, too little. ESG's proponents' responses to these critiques highlight crucial contradictions. Therein lies the truth about ESG.

ESG – much discussed, much praised, much maligned, is back in the news with the rise of the “anti-ESG” movement, growing in popularity in the right wing of U.S. politics. These critiques allege that integrating ESG into investment processes goes against investors fiduciary duty to maximise financial return. Conversely, ESG has also come under fire in recent times for not living up to claims that it creates meaningful environmental and social impact. 


So, with ESG under fire from all sides, where does the truth lie? Can ESG really save the world and continue to maximise financial returns? (Spoiler – it can’t). In the midst of these criticisms are the contradictions which reveal ESG’s true identity.


From one side – those who say ESG doesn’t do enough


In the blue corner, we have the growing swell of criticism that ESG, which has long been marketed as the investment industry’s answer to the world’s biggest social and environmental challenges, does not, in reality, contribute meaningfully to addressing these issues.


These critiques, although not new, gained momentum through Tariq Fancy, former Chief Investment Officer for Sustainable Investing at BlackRock. He pushed the message that ESG is a game of smoke and mirrors which achieves little impact and obscures the need for structural change through government regulation. Similarly, Aswath Damadaran, Professor of Finance at Stern School of Business is quoted as saying that ESG “creates more harm than good for society”.

"ESG cannot save the world. It is time to create breathing space for approaches which can."

From the other – those who argue it does too much


And in the red corner (quite literally), there is the right wing of U.S. politics, who make up the most vocal elements of the growing ‘anti-ESG movement’. The anti-ESG movement has labelled ESG as “woke” investing, as ESG is becoming increasingly politicised in the U.S.. Since the beginning of 2022, GOP lawmakers have tabled over 40 new bills that would punish ESG and sustainability-led business practices. A notable example of this is Florida Governor Ron De Santis, who led efforts to bar the state from considering ESG factors in its investments.

The ire of the U.S. right has also put the world’s largest asset manager and one of ESG’s most vocal proponents, BlackRock, into the limelight, with Republican attorneys general alleging that BlackRock is forgoing its fiduciary duty to maximise financial returns in favour of reaching climate goals.


In response, Blackrock, quoted in Politico, argued: “It is our duty to provide clients with our perspective on matters that can affect asset prices and to help them navigate constantly evolving industries and markets. Our commitment to our clients’ financial interests is unwavering and undivided.”


They are of course, correct. Any number of environmental, social and governance factors can pose a risk to a company’s bottom line, from human rights abuses in supply chains, to corporate corruption scandals, stranded assets and beyond. ESG in this respect, makes perfect fiduciary sense.


This counter-argument against the “woke investing” critique,however, exposes the contradictions of ESG, and those who extol its virtues. In arguing that incorporating ESG is essentially the process of considering a greater range of financially relevant risks, it's greatest criticism from one side has become its greatest defence against the other. Namely, that ESG first and foremost is not about investing in companies which have a significant positive impact on society and the environment, but rather looks at the environmental, social, and governance-related risks to a company’s financial performance.

This has provoked criticism from New York comptroller Brad Lander, who has accused Blackrock of abdicating responsibility for driving Net-Zero in their portfolios, going so far as to indicate that New York city's pension funds would reconsider investments if they are not aligned with their climate ambitions.


ESG, although still in the spotlight, is losing some of its shine. Positioned as a silver bullet which can deliver on a ‘profit with purpose’ platform, slowly but surely it is being shown that ESG cannot be all things to all people.

As one door closes, another one opens


All is not lost for ESG, however. As it is becoming increasingly clear what ESG is not, it can finally begin to be understood and be appreciated for what it is – a reactive risk management framework, which might - albeit inconsistently - reduce environmental and social harm or increase positive impact.


This was illustrated clearly in the Global Sustainable Investment Alliance’s ‘Global Sustainable Investment Review’ which claims that there are now $35 trillion in sustainable investments. $25 trillion of this is invested using ‘General Integration’ or ‘ESG Integration’ strategies, however, which require investors to consider ESG factors, but not necessarily act upon them. Our recent white paper demonstrated that ETFs employing this strategy exposed investors to barely improved sustainability outcomes compared to theirnon-sustainability focussed parent indices, and considerably underperformed alternative approaches.

By clarifying what ESG is and what it is not, which the likes of Blackrock have helped to clarify, space previously taken up by the all-consuming ESG is now left clear for new conceptions of investing for environmental and social good.


It may take some time to disentangle, as up to now the lack of clarity around ESG has meant distinct alternatives have been swallowed up by the ESG juggernaut. Nonetheless, a tighter understanding and delimitation of ESG will allow concepts such as impact investing, thematic investing, SDG investing and socially responsible investing to better define, establish and sophisticate themselves outside of the shadow of ESG (the world will wait and see what the right wing of U.S. politics will say about these different approaches to investment). It also creates the necessary bedrock for better data and better regulation to emerge and flourish.


This ‘win-win’ mentality won’t die without a fight, of course, since the ESG narrative has turned out to be such a lucrative line for so many. It is crucial, however, to highlight the inconsistencies in the rhetoric of those who would have everyone believe that they are saving the world, whilst also fighting to appease those unwilling to make any financial sacrifice in favour of genuinely sustainable investing.


ESG cannot save the world. It is time to create breathing space for approaches which can.


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