What had become an ever-increasing popular strategy for some of the biggest institutional investors over the years has now become a lightning rod of criticism from politically conservative circles.
ESG investing has been embraced by pension funds such as the $337.9 billion California State Teachers’ Retirement System and endowments like the $16 billion Ford Foundation.
Not all embrace the concept, though, as some state government officials — including in Florida — as well as federal lawmakers have criticized or taken actions to ban consideration of ESG factors in investments.
While the practice of ESG investing has existed in some form for more than half a century, “ESG” as a term was only introduced in June 2004, when the United Nations Global Compact published a report titled “Who Cares Wins.”
Representing 18 institutions with more than $6 trillion assets at the time, a working group of financial professionals provided recommendations to “better integrate environmental, social and governance issues” in asset management, securities brokerage services and financial research firms.
The report called on corporations to provide information and performance on ESG principles and policies. It also “urged” investors to “explicitly request and reward research” related to ESG aspects, adding that asset managers should integrate research on these aspects into their decisions.
“In 2004, many of us had become convinced that a number of criteria applied by socially responsible investors with an ethical lens also embedded investment materiality,” said Steve Falci, who was chief investment officer of equities at the Calvert Group when he was in the working group.
Falci participated in U.N. initiatives before being invited to collaborate on the report, which he was “excited” to be a part of. Calling the establishment of ESG “an excellent first step,” he is now the head of systemic and multiasset strategies at Impax Asset Management, which managed $50 billion in assets as of March 31.
And while some may oppose the three-letter acronym, “nevertheless, I continue to passionately believe that using an ESG lens to evaluate investment opportunities and risks helps investment managers to make better investment decisions,” Falci said.
BORN OUT OF A REBRANDING EFFORT
Socially responsible investment was the “designated term at the time,” said Eric Borremans, head of ESG at Pictet Asset Management, which had 248 billion Swiss francs ($274.8 billion) worth of assets under management as of March 31.
SRI sparked debates at the time where “people were saying: ‘Well, hang on, it’s not just about social issues. It’s also about the environment,’ ” he said.
Borremans was head of sustainability research at BNP Paribas Asset Management when he participated in the U.N. report’s working group.
At BNP Paribas, “we tried to coin it ‘sustainable and responsible investment,’ ” but there was “some pushback” as well as “some confusion,” Borremans said. But there was a need to have a term like SRI by its “nascent market” in France, where demand was driven by unions in what he calls “a unique phenomenon.
“There were a number of U.S. participants at the time, and ‘socially’ in the U.S. was translated as ‘socialist,’ so that didn’t get much traction.” So “we were thinking of another term more neutral [and] more materiality oriented,” Borremans said.
The group arrived at the term ESG, but it could have been something else.
“Initially, we were thinking of calling this ESC — the ‘C’ standing for corporate governance,” Borremans said. “Then someone in the group said, ‘Well, hang on, ESC sounds like what we all have on our keyboards, “escape.”’ We thought, ‘Oh, my God, we cannot call it ESC.’ And we said, ‘OK, let’s call it ESG.’ ”
The report also led to the 2006 creation of the U.N.’s Principles for Responsible Investment, a network composed of financial institutions that promotes sustainable investing through the lens of ESG factors. The establishment of the network was a key turning point as it is now the basis of many ESG strategies and signatories.
STILL A ‘CONFUSING AND AMBIGUOUS TERM’
Like SRI back then, ESG is sparking debates about what the standards are, how to measure it and how to compile it.
Even in 2004, the endorsing institutions acknowledged in the report that there are problems with the definition of ESG issues, citing a survey of CEOs and CFOs conducted in 2003 by the World Economic Forum.
While 70% of the survey’s respondents expected ESG issues to receive increased interest from “mainstream investors” in the future, they also highlighted obstacles that include problems with the quality and quantity of information.
The controversy around ESG investing today isn’t a surprise to Falci, who said the connotation of the term has broadened, and “is a confusing and ambiguous term, used by different people in different ways,” he added.
It was “never intended as a comprehensive, alternative framework for guiding the deployment of capital,” Falci said. But “when ESG is clearly articulated, ESG analysis is a useful investment tool to help investment managers to do a better job at evaluating the opportunities and risks arising from global sustainability challenges.”
Since 2004, conversations around the term have “grown to become dominated by climate change and, to a lesser extent, the just transition and social issues beyond that,” said Steve Waygood, chief sustainable finance officer at Aviva Investors. “Corporate governance has, in many ways, taken a relative back seat more recently, which has been unfortunate.”
“But the core concept that environmental and social issues are routinely material considerations to investors is now accepted wisdom by most active managers,” Waygood added. “It’s just the relative extent of financial relevance and — often — disagreement on directionality of impact that investors disagree about. But that very difference of opinion is of course what generates the market.”