Raise your hand if you don’t know what “ESG” stands for.
The three-letter acronym for “environmental, social and governance” has broken out from the wonky world of finance and into subway ads and online pitches for a slew of new ESG mutual funds, ETFs and other financial services.
“My mother knows what ESG is — exciting times,” Imogen Rose-Smith, an investment fellow at the University of California, says on the latest episode of ImpactAlpha’s Returns on Investment podcast.
The term covers any of dozens of environmental, social and governance factors that can affect the performance of public equities and other assets — from companies’ carbon footprint to their supply-chain labor practices to the representation of women on boards and in senior management.
How such “non-financial” factors affect financial performance has been a matter of hot debate for several years. As ESG breaks into the mainstream, the podcast’s roundtable regulars took on a tougher question is: Does it make a bit of difference in the real world?
“There’s a huge disconnect between sustainable investing, investing with purpose, or whatever you want to call it, and these social and economic realities we see around us,” Rose-Smith says.
A flurry of recent articles have tried to puncture the ESG balloon. An example of the genre is Bloomberg’s “How Socially Responsible Investing Lost Its Soul,” which suggests the marketing hype around ESG obscures a more prosaic motivation for fund managers: higher fees. Writes Rachel Evans, “Criteria are so broad and disparate that companies as unlikely as Exxon Mobil Corp. and Philip Morris International Inc., the maker of Marlboro cigarettes, make the cut in some cases.” (Vox weighed in with “ Socially responsible investment is a $12 trillion industry. Does it make the world better? Probably not.”)
To be sure, ESG criteria may help investors reduce their exposure to a range of risks, from climate-related disruptions to headlines about modern-day slavery in corporate supply chains. A case in point is the recent announcement from California utility PG&E that it would seek bankruptcy protection because of its massive liabilities for damages from the state’s devastating wildfires of the last two years.
The company had long been warning of its climate-related risks (as part of a lobbying effort to escape some of that liability) and ESG investment managers had taken heed: Of the roughly 1,200 sustainable equity funds tracked by Bloomberg, just 34 held shares of PG&E.
Yet “ESG hasn’t mitigated climate change itself,” noted podcast host Brian Walsh of Liquidnet. “It has helped those aware of climate change to navigate and protect their investments. But it’s not actually leading to fewer California wildfires.”
(That points to the distinction between largely passive – and public – ESG investing and more active, private-market impact investing. For the latter, investors might look at emerging structures such as Blue Forest Conservation’s “forest resilience bond.”)
Still, the longterm impact of ESG may be profound. The measurement and disclosure regimes developed under the ESG rubric are enabling corporate accountability at a level of detail never before possible. As those metrics increasingly get incorporated into algorithms and ratings, it is increasingly possible to reward good corporate actors and punish the bad ones. That is driving splits in the corporate ranks that system-changers can build on.
ESG is clearly not a cure-all for the world’s ills. But “the discussion moves forward, the predicate gets laid, the data gets collected and that sets the stage for the next set of demands,” I argued in the podcast.
“We need to take it the next level, beyond platitudes and rhetoric about purpose and even ESG, to ‘Let’s drive the capital in the direction we need the future investment to go. That’s what we’re now ready to do,” I said.
And since I wrote up this post, I get the last word. “I don’t want to spend our time trashing ESG. I want to get on with what we’ve now got the platform to do.”