Commentary: Is ESG a mere marketing tool to attract investors who want to do good?
While environmental, social and governance investments sound noble in theory, the problem is how ethical investment plays out in practical terms, especially when outcomes are hard to measure, says the Financial Times' Jonathan Guthrie.
LONDON: Would-be ethical investors today have the same problem as Mookie, a New York pizza delivery man, the protagonist of Spike Lee's 1989 movie, Do The Right Thing. They want to do the right thing. But it is often hard knowing what that is. When Mookie smashes his employer’s window during protests against police brutality, it is a conflicted choice. So is disinvesting from hydrocarbons.
Brisk demand has nevertheless channelled US$3.2 trillion into equity funds that claim to have environmental, social and governance (ESG) objectives, according to Reuters.
Scale, rightly, invites tough scrutiny. Trenchant critics of ESG investment include Tariq Fancy, a former BlackRock sustainability boss, Aswath Damodaran, New York University’s valuations wizard, and Robert Armstrong, lead writer of the Financial Times’ punchy Unhedged newsletter.
Many criticisms of ESG are justified. But I have yet to see a convincing argument against ethics as a factor in investment decision-making. The problem is how ethical investment is playing out in practical terms.
The ESG movement is riddled with category errors. Criticisms of ESG are not themselves immune from that drawback.
The biggest taxonomic mistake in ESG is the category itself. This creates a handy marketing tool for asset managers, such as BlackRock, to sell funds to customers who do not want their investments to finance bad stuff. The problem with the acronym is that it jams together disparate and sometimes contradictory objectives.
CAN ESG LEAD TO DECARBONISATION?
The environmental aim is clear: Decarbonisation. If you believe in anthropogenic climate change, there is a good long-term financial case to switch money from hydrocarbons to renewables.
Two years ago, Financial Times' business and finance column Lex calculated energy groups had stranded assets valued at US$900 billion that they could not extract without causing planet-frying temperature rises by mid-century.
Rising oil prices have since then dragged up the market worth of the seven largest quoted United States and European oil and gas companies by almost US$400 billion, or two-fifths, S&P data show.
Post-pandemic supply disruption and the Ukraine war are only partly responsible. You can also blame an ESG-induced shortage of investment in oil and gas projects. This, in turn, reflects the failure of governments to publish step-by-step decarbonisation plans for what amounts to the world’s largest-ever capital project.
VAGUE SOCIAL AND GOVERNANCE AIMS
The social aims of ESG are vaguer than the environmental ones. They tend to focus on the treatment of communities and workers.
Is it wrong to invest in a company that subcontracts garment manufacturing to workers in Bangladesh that are officially paid at least US$96 per month, about 5 per cent of the United Kingdom’s adult minimum wage? Or is the income a social good in a country where deprivation is rife? You tell me.
Governance is a catch-all title within a catch-all acronym. On one hand, good governance precludes bribery, money laundering and workplace sexual harassment - activities that are plainly immoral. On the other hand, it also prescribes box-ticking over the independence of non-executive directors and similar matters of little significance.
Cheerleaders claim that companies with high ESG compliance in the social and governance silos perform better. Evidence for this, typically based on the representation of women and minorities within businesses, is ambiguous.
The best argument against discrimination is that it is wrong, not that it might knock 20 basis points off operating profit margins.
How can we make money greener in the fight against climate change? Listen to CNA's The Climate Conversations:
ESG ONLY A FLAG OF CONVENIENCE
Returns, or the lack of them, are a weak point targeted by critics of ESG. Researchers from bodies such as the Organisation for Economic Cop-operation and Development (OECD) have struggled to identify outperformance by ESG funds.
But returns are something of a straw man argument against ESG. Big asset managers do not promise investors better paybacks from ESG funds. They just pledge better morals, which are conveniently harder to measure.
Critics of ESG attack this second weak point by highlighting apparent failures. Russia’s brutal invasion of Ukraine has provided an opportunity. For example, a Bloomberg study found that ESG funds held US$8.3 billion in Russian equities. But most of us failed to foresee Vladimir Putin’s blood-drenched experiment in overreach.
Principled investors should respond to the category errors of ESG by pigeonholing themselves more adeptly. If their temperaments and time pressures recommend passive funds, they should remember that ESG is only a flag of convenience.
Otherwise, they should unbundle this cumbersome category and try to do the right thing, unaided. They will often fail. But that is the human condition.