It is a powerful feeling to think that your investment choices could potentially heal our planet. Imagine your investment decision is one more dollar heading right up into the sky, like a tiny band-aid to help plug that big gaping hole in the ozone layer. Unfortunately, that is precisely what the investment industry wants you to believe. ESG (environmental, social, and governance) sustainable investing has so much hope in theory, but it has a long way to go to fulfill those lofty goals.
According to Investopedia, "Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights."
The Good News
Demand for ESG investments has accelerated rapidly. Investors in private markets and on public stock exchanges poured $65 billion into climate technology companies in 2021, according to Bloomberg NEF, roughly equivalent to the gross domestic product of Algeria. It leads many investors to believe that the investment industry can bring change by embarking on a moral crusade. This journey can bring change if handled properly, but the attention has drawn much criticism, proving there is still work that needs to be done.
Knowing that investors are more interested in ESG investments than ever, investment firms are offering ETFs (exchange-traded funds) and other financial products that follow ESG investing strategies. This sector is expected to proliferate in the coming years, only amplifying the call for more transparency and the need for managers to vet these magnanimous offerings.
ESG investing is altruistic and strives to heal and protect our planet from the ravages of greenhouse gas emissions, foster social justice, and create sustainable business practices. In addition to their social value, ESG criteria can help investors avoid companies that are risky or working in an unethical manner. Wanting to hold companies to higher standards regarding human rights, animal welfare, and environmental concerns is something that can drive companies to contribute to real change for the common good.
The Bad News
ESG investing is booming. The attention has drawn numerous studies and plenty of critics. Per various studies summarized by HBR here, many companies in ESG portfolios had worse compliance records for both labor and environmental rules.
One writer referred to ESG investing as a "pillar of false virtue." Add this opinion to academic studies, such as one from Stanford University conducted in September 2022. They found that "the booming business of rating companies based on their environmental, social, and governance (ESG) performance is flawed by inadequate standardization and incomplete and inconsistent data."
Some ESG funds will charge fees 40% higher than traditional funds. In addition, confusion about reporting has aggravated investors when they discover those funds are not delivering the promised higher returns or helping the planet.
ESG investing is currently on a scoring system that uses independent measures. These measures are up for scrutiny and were the focus of the first week of the COP27 Summit in 2022, calling for transparency and an end to the false reporting of emissions by almost every country involved. But, unfortunately, ESG investing's growth and popularity have diluted the metrics and principles that help keep the underlying investments aligned with sustainability goals.
The current spotlight on reporting is confusing to investors, asking whom to trust and wondering if we are all victims of greenwashing. These opinions are solidified by the multitude of articles that all seem to be pulling the curtain back.
"According to Bloomberg, "[ESG] ratings do not measure a company's impact on the earth and society. They gauge the opposite: the potential impact of the world on the company and its shareholders." HBR.org 8/22
Fighting climate change is entirely different from measuring and assessing the climate risks to a firm's profits.
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Why Should You Care?
ESG investing will not go the way of the dinosaur. On the contrary, it will continue to grow in popularity. The hope is that the louder the critics voice, the more change can occur, and companies can deliver honest reporting and eat their own cooking.
Here are a few things to consider when contemplating an investment in an ESG investment or fund:
The inherent value of ESG investing is ultimately contingent upon whether it drives authentic change in the three areas it seeks to transform or is merely an exercise in questionable reporting.
ESG is extremely specific and may need to be tailored to meet the needs of each investor. Asset managers and corporate entities have used a "one-size-fits-all" approach when defining ESG. As with religion and politics, everyone will have a different perspective. This makes ESG a subjective but worthy goal, nonetheless.
Vineyard Global Advisors offers a range of investment strategies designed to allow participation in the market's growth within a dynamic, risk-managed framework that seeks to provide protection during significant market declines. Our goal is to give our clients greater peace of mind by generating steadier returns over time.
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