ESG - "Extremely important and Nothing special"
In recent years, the landscape of Environmental, Social, and Governance (ESG) investing has seen a remarkable shift. While ESG factors were once enthusiastically embraced by investors, it appears that the tide is turning. The Association of Investment Companies' annual ESG Attitudes Survey revealed that the number of respondents considering ESG factors when investing dropped from 60% in the previous year to 53% in the most recent survey. Additionally, global assets under management in ESG funds decreased by approximately $163.2 billion during the first quarter of 2023. What's behind this change?
1. ESG Investing Performance:
One of the key factors influencing the decline in ESG enthusiasm is the performance of ESG investments. A study by Scientific Beta found that portfolios of exchange-traded funds (ETFs) following ESG strategies did not outperform standard index funds. On average, ESG ETF funds underperformed by 0.2% annually when compared to a proxy for the US equity market. This revelation has led some investors to question the efficacy of ESG strategies.
2. Greenwashing Concerns:
Skepticism regarding ESG claims from funds has grown significantly. In 2021, 48% of investors expressed doubts about ESG claims, but this number has now risen to 63%. This increased skepticism is reflected in the outflows from the Responsible Investments category. In August, a record £448 million (US$546 million) was withdrawn from these investments, suggesting that investors are becoming more discerning about ESG-related claims.
3. Politicization of ESG:
The politicization of ESG investing has further complicated matters. Approximately half of US states are implementing measures to restrict ESG-based investment in state-run accounts, and a coalition of Republican-led states has challenged the Biden administration over rules allowing climate change factors to influence 401(k) investments. This political environment adds uncertainty to ESG investing.
However, it's important to note that this article is not primarily about the reasons behind the decline in ESG enthusiasm; it aims to delve deeper into the essence of ESG itself.
ESG: A Shifting Landscape
From its inception, ESG has undergone a transformation. Now, it gets to the point, as quoted by London Business School finance professor Alex Edmans "extremely important and nothing special."
The core challenge with ESG lies in its investor-centric approach, which has turned it into a product of the mutual fund industry. However, true corporate sustainability cannot be defined solely by catering to investors. It involves a more holistic approach that considers the needs and interests of customers, consumers, and employees as critical stakeholders. To achieve alignment between profit, planet, and people, organizations must foster a culture of sustainability throughout their entire structure rather than relegating it to a small reporting department.
While the term "ESG" has been somewhat diluted, there's hope in the current trend. It's time to shift the focus towards tangible and concrete issues like climate change, diversity, equity, and inclusion, and supply chain human rights. Building strong relationships with suppliers, customers, employees, and communities is essential for a company's long-term success. This focus on the fundamental aspects of sustainability helps us strip away the superficial "woke" elements that have crept into ESG over the past decade, returning us to the essence of what truly makes a company sustainable.