An ABC on the flavors of ESG and sustainable investing: QuickTake



You’ve probably heard of ESG and may be familiar with it as a form of investing and financing that involves considering material financial risks related to environmental factors, social issues and corporate governance issues. . If you’re like most people, you’re probably unclear about the difference between ESG and socially responsible investing, impact investing, and similar, sometimes overlapping approaches, in part because ESG has come to mean different things to different people. This vagueness has helped fuel rapid growth in recent years. But with that growth has also come increased scrutiny from regulators who are cracking down on banks and investment firms that make overstated claims. In the United States, ESG has also faced backlash from conservatives who call it “woke capitalism” and insiders who say it doesn’t create the kinds of real-world impacts it does. seemed to promise.

Here is a guide to the basics.

1. What’s the big idea?

The broadest umbrella term for the strategy of which ESG is a part is sustainable investing. Proponents say the goals of sustainable investing, which covers fund assets valued at $2.7 trillion globally by Morningstar Inc., are to have societal impact, align with personal values ​​or manage risk. And making money along the way, of course.

2. Where does ESG come from?

The acronym was coined in the mid-2000s. A UK law firm wrote a report for the United Nations Environment Program Finance Initiative in 2005, claiming that the use of ESG factors in the financial analysis was consistent with the fiduciary responsibilities of investors. The idea was that the integration of ESG data would help protect investments by avoiding significant financial risks related to factors such as climate change; labor disputes and human rights issues in supply chains; and poor corporate governance and resulting litigation. Over time, the label has come to be applied to investments ranging from predictable things like owning renewable energy stocks to things you wouldn’t expect, like funds that track reference containing oil companies or assets in autocratic countries. like Russia.

Estimates vary depending on what people count as ESG. According to Bloomberg Intelligence, assets are expected to grow to $50 trillion by 2025 from around $35 trillion currently. They rose from $30.7 trillion in 2018 to $22.8 trillion in 2016, according to the Global Sustainable Investment Association.

The popularity of ESG depends in part on the belief that it will play a positive role in making the world a better place. But critics say such warm and fuzzy sentiment helps asset managers blur a key distinction – that ESG is primarily about using data to identify risks that could harm investment performance or to find money-making opportunities. This contrasts with some other branches of sustainable investing which sometimes go further:

• Ethical and values-based investing: These are general strategies that allow investors to avoid or invest in companies that reflect their political, religious or philosophical beliefs and values. Its earliest followers were religious groups such as the Quakers who avoided investments in things like alcohol, guns, and gambling. Church-affiliated groups in Sweden launched the first ethics-based mutual fund in 1965. The Pax World Fund was launched in the United States in 1971.

• Socially Responsible Investing: Galvanized by Vietnam War protests, consumer boycotts of napalm producers and efforts to end apartheid in South Africa, a group of investors in the 1980s and 1990s sought to do good by not only avoiding companies that harm society, but investing in those that improve their business practices. They can also focus on companies engaged in clean technology efforts.

• Impact investing: While socially responsible investing tends to focus on publicly traded companies, impact investing focuses on private projects. It’s a niche strategy where investors target specific outcomes that can be measured, such as promoting sustainable agriculture or businesses that provide affordable housing.

• Systems-level investment: A nascent strategy that has yet to take off. As people increasingly point to the failure of ESG to catalyze big and real impacts, they are looking to invest at the systems level. This involves making decisions that consider your entire portfolio and how its elements intersect across all long-lived assets. An example would be climate change: a systems-level approach would look at how it affects entire portfolios, from stocks in energy and insurance companies to sovereign bonds and currencies. Systems-level investors are then expected to work with other investors to collectively push companies to improve their business practices by creating industry standards, sharing data with other investors, and lobbying for public policy changes. .

5. What do critics of ESG think?

Some believe the term has become so broad that it loses much of its meaning. Many point to the prevalence of greenwashing, which occurs when companies exaggerate the environmental benefits of their actions. Even the man who coined the acronym said the financial industry had sprinkled ‘ESG fairy dust’ on products that didn’t deserve the label, and there would be industry upheaval. in the years to come. Other criticisms relate to the way fund managers rely on ESG ratings which rank companies based on their performance on ESG factors. There is a lot of inconsistency in these scores – in some cases, companies are ranked based on the risks the ESG factors pose to them rather than, say, the risks the companies pose to the environment and society.

6. What do regulators think?

With the ESG label now widely used by fund managers and bankers selling everything from mutual funds to complex derivatives, regulators in Europe and the US are cracking down on companies that overstate their ESG bona fides. In May, German authorities raided the offices of Deutsche Bank AG’s fund unit amid allegations that it overstated its ESG capabilities to investors. The following month, it emerged that US regulators were investigating whether ESG funds sold by Goldman Sachs Group Inc.’s asset management group breached ESG measures promised in marketing materials.

The U.S. Securities and Exchange Commission proposed a list of new restrictions in May aimed at ensuring ESG funds accurately describe their investments, and which may require some fund managers to disclose greenhouse gas emissions from companies in which they invest. These proposed rules come on the heels of new laws in Europe, the Sustainable Finance Disclosure Regulations, where investments must be labeled in categories commonly referred to as “light green” and “dark green”, depending on the priority given to sustainability.

8. Does sustainable investing really make a difference?

A cohort of ESG executives and academics lamented the strategy’s lack of far-reaching, long-term impacts. Of course, sustainable investors have made strides, such as pressuring companies to reduce their use of plastic, addressing workers’ rights, and conducting so-called civil rights audits. They also succeeded in replacing the directors of the board of directors of Exxon Mobil Corp. to help the oil giant position itself towards cleaner fuels. Other supporters said that if investors in Deliveroo Plc in the UK had considered ESG issues, they could have avoided losses after the company faced a backlash over operating the economy gigs and workers’ compensation last year. Yet critics argue that the idea that ESG investing alone is enough to solve complex problems is proving wrong, and that greater government intervention is needed to solve societal problems such as living minimum wages and greenhouse gas emissions.

9. How do these approaches compare in terms of return on investment?

In three categories – Europe-focused, US-focused and global – large-cap ESG equity funds have done better this year, on average, than their non-ESG counterparts. Although they lost money – consistent with the market selloff – those losses are smaller. Globally, ESG funds are down 11.7% this year through June 10, compared to the 14.8% drop in the MSCI World Index. But there have been some early signs that investors are depreciating on ESG. They withdrew a record $2 billion net from U.S. exchange-traded funds in May, ending three years of inflows, according to Bloomberg Intelligence.

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