ESG investors ignore anti-ESG backlash
For the past two years, even the most experienced financial professionals are struggling to get the current ESG story straight. Recent months have seen a mélange of conflicting reports about legislative anti-ESG backlashes followed by pushbacks to the backlashes, claims, and counterclaims over performance and ratings, reclassification of ESG funds, arguments over materiality/non-materiality, charges of greenwashing and greenhushing, and varying definitions of what exactly ESG is, anyway.
No stopping ESG investing
The confusion, though, has not stopped the growing popularity of ESG investing worldwide. The first quarter saw net inflows across ESG debt, equity, and multi-asset funds of $25.5 billion, the best quarter since early 2022. This growth spurt was preceded by a rise in 2022 in global ESG fund assets, which stood at $2.5 trillion at the end of the year, a 12% increase that was almost double that of the broader global fund market.
Several drivers are fueling the continued growth of ESG investing. Among them, the funding boost provided by President Biden’s pro-green investment Inflation Reduction Act initiative, a rebound in the values of tech stocks (which figure large in ESG fund holdings), and strong demand from asset owners and retail clients for values-based investing, particularly in the area of the clean energy transition.
Grass roots ESG investing bucks the anti-ESG political backlash
Why has ESG investing withstood a savage anti-ESG campaign by conservative American politicians? Easy answer: It’s the money. Investors want to invest in ESG funds. Billions of investment dollars have been deployed into ESG-flagged funds, with billions more in the queue. It’s an investing revolution being driven by market “ask,” a unique, bottom-up form of financial innovation rather than a strategy imposed by policy.
A global financial phenomenon
ESG has grown greatly since the first popular use of the term in 2004, in a report titled “Who Cares Wins,” an initiative of the UN Global Compact supported by 20 global financial institutions. From that white paper launch, ESG now stands as a global financial phenomenon. Asset managers globally are expected to increase their ESG-related assets under management (AuM) to US$33.9tn by 2026, from US$18.4tn in 2021. With a projected compound annual growth rate (CAGR) of 12.9%, ESG assets are on pace to constitute 21.5% of total global AuM in less than five years, says PwC.
Why has ESG investing withstood a savage anti-ESG campaign by conservative American politicians? Easy answer: It’s the money.
Despite the ESG dollar inflows, the controversy over the relevance of ESG continues. Two narratives are currently competing to address the problems with ESG’s promise. One camp, favored by Republicans, wants to abolish all things ESG. ESG is a fraud, say critics, and its existence should be eliminated by legislative fiat because it violates existing fiduciary duty requirements by including “non-material” factors. The other promotes ESG as an essential tool in addressing such large, systemic issues as climate change, and as an emerging investing factor that can and does result in outperformance over time.
Who is right?
To get to the bottom of this debate, let’s back up to the basics. As ESG practitioners and pundits have repeatedly said, ESG is just data. It is not a product or a ratings system in itself. In fact, many say that there is no such thing as ESG investing—just data to be integrated with other material factors. By their reckoning, ESG is often defined by marketing types and its critics as something it is not: as a product, even an ideology. And ESG scores, they caution, are relative and variable, with as many methodologies as there are ratings agencies (estimated to be as many as 630 and counting).
So, it’s more accurate and more useful to think of ESG as a verb, not a noun; as a process, not a product.
The hidden benefit of transparency
By all accounts, what ESG data has also proven is very useful for its transparency. The amount and quality of data today available to investors is exponentially greater than that of just five years ago. Assuming that the current tsunami of ESG data can be crunched, digested, and summarized for action (and AI is right on time for this work), its value has been demonstrated as a guide for managing risk and identifying opportunities—and for performance outcomes.
As ESG practitioners and pundits have repeatedly said, ESG is just data. It is not a product or a ratings system in itself. In fact, many say that there is no such thing as ESG investing—just data
A new Morningstar report finds “no performance sacrifice” over the long term for ESG investors. Those findings are based on review of ESG fund performance across 17 European categories over three, five, and 10 years. Another report from Fiscal Note / ESG Solutions describes six organizations that are “crushing it” in proving the return on investment of ESG. And a paper by Bain & Company and EcoVadis outlines the link between sound ESG management across supply chains with better margins, connecting business value creation and ESG. Efforts to “put the dollar sign in ESG” by translating ESG metrics into monetary terms to be used for capital allocation will continue to develop as the market expands.
And just when you thought you understood ESG …
Here’s a heads up, re a new speed bump that is emerging: As fast as the ESG confusion is cleared up, new complications re-cloud the picture. The ESG reporting and regulatory landscape will soon become more complicated than ever before, as the European Union and United Kingdom issue new policies and frameworks. New regulations coming into effect will expand the scope and content of ESG reporting standards. Other proposals include regulating the transparency and integrity of ESG ratings agencies.
As outlined by Joel Makower, chairman and co-founder of our strategic partner GreenBiz, and Climate & Capital content partner, it’s a complex set of rules and regulations. He summarized it as “CSRD, CSDDD, ESRS, and more: A cheat sheet of EU sustainability regulations.” It’s a good primer for what American financial professionals will have to deal with. Because despite the pushback to globalization, it’s still a global economic world, and U.S. multinationals will have to comply with those standards where they apply.
Then there’s the Securities and Exchange Commission, which is working up its own set of regulations for U.S. corporate reporting disclosure, expected to take effect later this year.
One more thing: I’m counting on a powerful intangible factor to be a guiding light through this murky landscape: the yearning for authenticity on the part of those who deeply care to be responsible investors for the betterment of the planet. Next week I will have a front-row seat on the best ESG thought leadership at Makower’s must-attend GreenFin 23 sustainable finance event in Boston.
