ESG, the environmental, social and governance concept, has fuelled a surge in mutual fund launches over the past four years. But popular though it may be, there are those who say that the way it is marketed is no longer helpful.
It was only in 2004 that ESG was even heard of, when it was used in a UN-sponsored report, as part of a response to the corporate governance disasters of Enron and WorldCom. But it was a slow burn. Then, however, about 2018, the concept took off. The world woke up to the environmental degradation around them, and this gave fund management marketeers something to work with. ESG mutual funds and exchange-traded funds became the industry’s fastest-growing products.
Yet people talked about ESG without really explaining what it was. For example, is it a positive screening, so fund managers only invest in clean energy, or is it a negative screening, so fund managers don’t go for the likes of tobacco or defence? Is it for companies like Tesla, highly rated for its electric car? But to prove how difficult this is, Tesla is also lowly rated because of the rare earth and other minerals used in its batteries.
If the climate is so wrecked 30 years hence, members’ financial profits will be largely irrelevantThe US Federal Reserve and the European Central Bank (ECB) cannot agree either. Fed chair Jerome Powell said his organisation should “not wander off to pursue perceived social benefits … We are not, and will not be a climate policymaker”, he told a conference of the Swedish Central Bank in January. However, in its 2021 strategic review, the ECB committed to incorporating such environmental concerns. At the same conference Isabel Schnabel, a member of the ECB executive committee, again pledged that its policies should be “aligned with the objectives of the Paris Agreement to limit global warning to well below two degrees”.
The Fed versus ECB split mirrors the one between the United States and Europe. Sarah Keohane Williamson, chief executive of FCLTGlobal, a Boston-based organisation that researches long-term investing, writes in the Financial Times (article dated 27 August 2020) that Europe is moving towards ESG being part of corporate risk analysis. She says that America is going the other way, saying that ESG must be subservient to financial returns in, for example, pensions.
She suggests that this is because Europeans take a long-term view of value creation whereas American regulators are focusing on the short term. The Europeans talk of ‘double materiality’, meaning companies should worry about long-term climate change as well as short-term profit. If the climate is so wrecked 30 years hence, members’ financial profits will be largely irrelevant as there won’t be much to spend it on. Similarly, discrimination, unfair wages, and other ESG issues will affect companies and society in the long term.
But the American view is more nuanced than it sometimes appears. Wall Street seems more inclined to use ESG as a part of the corporate manual and as a risk measure. On the other side, however, the Texas legislature has boycotted 350 funds and 10 financial firms that use ESG metrics, to stop them from managing state pension funds.
The Texas economy relies on oil, but this is not true of Florida. Yet Ron DeSantis, Florida governor and a likely presidential candidate, said there was a “perversion of financial investment priorities under the euphemistic banners of environmental, social and corporate governance and diversity, inclusion, and equity”.
The problem is that ESG does suffer from being ambiguous. In the UK, Stuart Kirk, formerly of HSBC, quit in July 2022 after backlash to a speech he gave where he argued that climate risk should not be considered investment risk. In a later column in the Financial Times (5 September 2022), Gillian Tett writes that he believes in ESG in a general sense but is frustrated with the way it is being practised. He grapples between the ‘input’ effects – the world’s ESG problems hitting a company’s bottom line overall, versus the output – how the company affects the world.
Some companies are also ‘greenwashing’ – making statements about their efforts to curb carbon emissions which are impossibly vague. This led in May 2022 to a raid by German police on asset manager DWS as part of a greenwashing probe. Other regulators, including the UK regulator the Financial Conduct Authority, worry about whether the products of ESG asset managers are “fair, clear and not misleading”.
All this suggests ESG is a bit lacking. Almost every company hits some goals positively but others negatively. To say that a company is good or bad is too vague. Much better to separate ESG into its components and then use league tables to rate them individually, rather than relying on a hit or a miss.