If you read anything about ESG in 2023, you probably were reading about a political debate. From the volume of articles on the debate, it might seem as if the movement to sustainable investing is a political one. This is false.
There is nothing inherently political in nature about ESG. When defined correctly, it is just a term to describe data on companies that might not be included in their standard financial reporting. But the term ESG is rarely used correctly anymore. It has been caught up in the culture wars and used on both sides of the political spectrum to stoke animus.
ESG as the bogeyman
Much of the blame for these anti-ESG attacks belongs to our hyperpartisan political system. Some politicians in the U.S. are fueling the culture wars by calling out ESG as the bogeyman. Agitators on the right claim that ESG is an attempt to force companies to adopt the far left’s progressive, liberal and "woke" agenda. And they claim that, if left unchecked, ESG will limit corporate profits and leave America without enough energy resources. And from the left we hear that ESG is just a dangerous distraction, akin to rearranging the deck chairs on the Titanic. These pundits seem to believe the profit motive will always lead to bad outcomes, so stronger regulation is needed to curb capitalism’s destructive ways.
It is easy to criticize ESG. It is a relatively new investment discipline — the term was only coined in 2005. It is neither the distraction nor the bogeyman that it has been made out to be.
But the investment management industry is at fault as well. As interest in sustainable investing has grown, fund managers have too often chosen terminology for marketing reasons rather than for accuracy. This lack of discipline in the use of terms for sustainable investing has created confusion about what ESG actually is and what it isn’t.
The difference between ESG and SRI
There are forms of values-based investing where you can push a political agenda, but that isn't ESG or environmental, social and governance. That is SRI or socially responsible investing. SRI investors have historically divested from companies they don’t like and invested in those they do. Some SRI investors shun guns, others embrace them. Some SRI funds avoid so-called "sin stocks" like alcohol and tobacco, but other funds are explicitly investing in these firms. SRI is customized to whatever the investor wants, so it can be conservative or progressive or religious or deeply personal.
Unfortunately, ESG has become a catchall term for all forms of values-based investing. This lazy and inaccurate definition creates confusion for investors and leaves an opening for attacks from all sides.
A more accurate description of ESG would help both investors and politicians understand it better. ESG is an investment process that examines the risks to companies arising from their environmental footprints, their social impacts and their governance practices. ESG data can illuminate which firms pollute more, which have labor issues and which have inadequate risk controls. This is why more of the largest investors around the world are embracing ESG:·
- 12 of the 15 largest pension funds in the world employ ESG.
- 75% of sovereign wealth funds use ESG.
- 47% of central banks integrate ESG.
It is difficult to see how these large institutional investors could be investing with a political agenda. After all, they are investing on behalf of millions of investors who have a myriad of different values. They are not excluding coal companies or reducing their portfolio’s carbon footprint to be politically correct. They are doing it to reduce risk.
Focusing on materiality
These investors are hungry for any additional information that helps them better assess risk. More data and more transparency help markets digest and price risk more accurately. You need not be a sustainable investor to want this information — even conventional investors want a fuller risk picture.
Recognizing this, the Securities and Exchange Commission will soon publish guidance on new climate-risk disclosure requirements for public companies. The proposed rules are expected to require companies to report their greenhouse-gas emissions and exposure to climate risk. Climate-change risk is real and therefore a concern for all investors, whether sustainably minded or not.
ESG is a term that should remain focused on material issues. The issues that are material can alter the financial status of the company in the near term or are of such pressing concern to the community that they could affect the finances of that company longer term. If an issue is more about politics than profits — like abortion and gender pronouns — it is an SRI issue and not often material. Individuals can choose to invest with ESG and/or SRI in mind. It is their personal money. Public funds, on the other hand, like government pension plans and city treasury departments, should potentially consider ESG and stay away from SRI.
The political rhetoric is overheated enough. It doesn’t need more fuel to burn, and we would be wise to keep investment strategies out of the fire. We certainly don’t want politicians deciding how we should invest.