Another inconvenient truth - Is ESG investment doing more harm than good?

24th March 2022

ESG investment is coming under intense scrutiny, with some saying it could be doing more harm than good. Chris Seekings speaks to three experts

Environmental, social and governance (ESG) investing has exploded in popularity during the past decade, enticing investors with the promise of making financial returns while tackling the world’s greatest challenges.

A record US$649bn was poured into ESG-focused funds worldwide last year, according to the latest Refinitiv Lipper data – up from US$542bn and US$285bn in 2020 and 2019, respectively. Such funds now account for 10% of global fund assets.

Furthermore, a recent survey by Natixis Investment Managers found that around three-quarters of institutional investors believe ESG considerations are now an integral part of sound investing, and half think that companies with better ESG track records generate greater returns.

“We focus on sustainability not because we’re environmentalists, but because we are capitalists and fiduciaries to our clients,” BlackRock founder Larry Fink wrote in a letter to CEOs earlier this year. “Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘woke’. It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper.”

However, ESG investment has come under scrutiny recently after one of Fink's former employees questioned its impact in the essay ‘The Secret Diary of a Sustainable Investor’. As chief investment officer for sustainable investing at BlackRock – which manages over $6.8trn of assets – Tariq Fancy oversaw ESG considerations throughout all of the firm's global investment processes.

He tells me: “As a trained investor trying to integrate ESG into the largest pool of assets available in capitalism, there's no question in my mind that what the world thought ESG was, was not what I saw.”

Fancy argues that the impact of ESG investment is overstated, and discourages governments from implementing the changes needed to tackle key environmental and social issues. “It's been nearly a year since I've gone public. I've written in USA Today, The Economist, Financial Times, The Wall Street Journal, and BlackRock's PR engine knows that I'm saying this, yet they've studiously avoided entering the debate.”

The Financial Conduct Authority and the European Commission are now paying close attention to accusations of greenwashing in financial services. Here, Fancy and two other experts outline their concerns.

Tariq Fancy

Tariq Fancy
CEO, Rumie; formerly chief investment officer for sustainable investing, BlackRock

“There’s no reason to believe it changes anything”

My biggest concern is the lack of evidence of real-world impacts. People believe that, if you buy an ESG product, you're investing in or providing capital to 'good' companies, when in reality you're just moving to a slightly different basket of public shares. Some hedge funds will happily still buy them, so you're just reshuffling around things that already exist. People get the privilege of feeling like they're backing something good. In reality, based on how financial markets work, there's no reason to believe it changes anything.

The narratives are also very dangerous. They say you can invest in a low-carbon exchange-traded fund (ETF), beat the market, make money and fight climate change, a win-win. It's a convenient fantasy, but we have an inconvenient truth: it's going to cost trillions to remake an energy system that was built to exploit cheap fossil fuels. It's like there's a cancer patient, and we're giving them a well-marketed green juice. It sounds nice, but it's not going to slow the cancer.

The best thing we could do is regulatory reform; the most wide reaching one is a carbon tax – that's the most systemic piece of the puzzle. Before the pandemic, 71% of Americans believed that the economic system was rigged, and I believe it is also. I don't think anyone individually is to blame, it's just that the system will always optimise for profits, because it's legally obligated and financially incentivised to, and has been for 50 years. People aren't incentivised to burst the bubble.

The ESG community could be more honest about what works, rather than giving crazy promises. That might mean that not every fund can claim to be green. The ESG community should also pay a lot more attention to the role of companies driving regulatory change – any company that hides their political spending, should get a zero in ESG, period.

Every year words for ESG grow alongside carbon emissions inequality, which destroys faith in capitalism, and I am a capitalist. From the view of younger people, it doesn't look like a mistake, it looks like a heist.

David Picton
Senior vice president of sustainability, Alcumus

“Customers expect proof and third-party audit”

Critically evaluating an organisation’s role in society is not new – early philanthropic business owners ran positive schemes in the 19th Century. But increasingly, well-constructed ESG programmes are much more mainstream, organisations engage with sustainability more meaningfully and many lean into it on the risk agenda as an opportunity for value creation – and a way to underpin purpose.

There are indeed increasing legal requirements, but this misses the impact and influence of arguably the most potent force – customers and society in general. COP26 undoubtedly accelerated the carbon reduction emphasis. The number of organisations committing to a science-based target almost doubled in nine months, alongside a 35% rise in those disclosing their footprints to the Carbon Disclosure Project (CDP). However, powerful expectations from clients, employees and suppliers extend beyond climate action, through social value and on to areas of governance like ethics, anti-bribery and cyber-security.

The most effective ESG strategies embrace the three CBs – setting a Challenging Balance (across 3 ESG pillars) that Changes Behaviours (across teams) for Commercial Benefit (long-term success). At Alcumus, our global client research showed that most businesses see significant impacts from ESG, expecting this to increase still further over the next few years. Nine out of 10 organisations are either already investing or planning to adopt technology and tools to track their ESG performance.

With a sharp eye on greenwashing, customers and commentators expect proof, evidence and third-party audit to back up those ESG claims. Coherent data visibility is key to deliver that, connecting disparate operations across complex organisations and their supply chains. Moreover, for ESG strategies to really matter to the people who matter, they must have genuine action plans, track the outcomes and be authentic. That realisation is driving companies to move away from spreadsheets and manual calculations, and towards one true view of their ESG data through digitised technology platforms.

The answer to more sustainable business will hinge on a three-way dynamic, combining trust in organisations, legislation to steer specific areas and, crucially, the rising element of societal expectations.

Matt Orsagh
Senior director of capital markets policy, CFA Institute

“We have to change how we live – not how we invest”

More and more ESG investment vehicles are making their way to market. Don’t be fooled by them. They are often chasing the trend of ESG investing, because firms see profit in offering ESG funds.

Some of them may indeed perform rigorous analysis to integrate ESG in to the investment process, but that is rare. The difficulty is that many fund prospectuses use the catch-all phrase ‘ESG’, which makes them hard to compare. It is the responsibility of investment professionals to improve transparency in the industry, to ensure investors’ good intentions are met when looking to invest sustainably. To contribute to this aim, CFA Institute recently launched its Global ESG Disclosure Standards for Investment Products, a set of guidelines for fund managers which aims to improve disclosures of how an investment product considers ESG issues.

Because there is no agreed upon definition of ESG, investors also need to do their due diligence. They need to do their homework to ensure that the fund they are buying has a similar definition of ESG as they do. Most ESG funds are not structured to contribute to solving a problem like climate change. ESG funds are mostly created to tilt towards companies that will suffer less or benefit more in a certain environment, such as a carbon constrained world. If investors want to invest in 'outcomes' or 'impact', they need to look for specific funds that focus on impacts. Most ESG funds do not.

To tackle big issues like climate change, or biodiversity loss, we must make different societal choices. Not putting more carbon in the atmosphere in the first place is far more impactful than what ESG fund you choose. Changing our diets and how and where we live will positively impact the biosphere more than that new shiny sustainability fund. But it is hard to change behaviour, it is easier to just throw money at a problem. You can save the world, but you will have to change how you live – not how you invest.

Image credit | iStock

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