What is ESG investing? In short, it is a form of investing and finance that considers material risks related to the environment, social issues, and corporate governance.
Most people don’t understand the difference between ESG and socially responsible investing, impact investing, and similar types of sustainable investing because different people define ESG differently. This vagueness has fueled the recent growth in ESG investing.
In addition to the growth in ESG investing, regulators have cracked down on exaggerated claims by banks and investment firms.
Conservatives in the US have also criticised ESG as “woke capitalism”, and investors argue that it is not bringing the kind of impact it promised.
Where did ESG come from?
The acronym was created in the mid-2000s. A British law firm argued in 2005 that investors’ fiduciary responsibilities could be fulfilled by incorporating ESG factors into their financial analysis.
By incorporating ESG data into investment decisions, investors could avoid material financial risks associated with climate change, worker disputes, and human rights violations in supply chains.
As time has passed, the label has been applied to a wide range of investments, from ordinary things like renewable-energy stocks to nontraditional investments like funds tracking oil indexes or assets in autocratic countries.
How big is ESG investing?
There is no consensus on what constitutes ESG, so estimates vary. Bloomberg Intelligence estimates that assets will grow to $50 trillion by 2025 from $35 trillion today.
ESG’s popularity has been partly driven by the belief that it will make the world better.
However, critics contend that such a sentiment blurs a fundamental distinction – that ESG mainly involves identifying risks that could undermine investment performance.
What do critics think about ESG?
In some circles, it is thought that the term has become too broad and has lost much of its meaning.
There is a lot of talk about greenwashing, which occurs when companies exaggerate their impact on the environment.
The man who coined the acronym has admitted that the finance industry is sprinkling “ESG fairy dust” on products that don’t deserve it and that industry shakeout is inevitable.
Other criticisms focus on how fund managers rely on ESG ratings that rank companies by their performance on ESG factors. There is much inconsistency in those scores.
Sometimes companies are ranked based on the risks that ESG factors expose them to rather than their threat to the environment and society.
What do regulators think?
European and US regulators are cracking down on firms exaggerating their ESG credentials.
For example, a raid was conducted in May 2022 by German authorities on the fund unit of Deutsche Bank AG amid allegations that the group overstated its environmental, social, and governance capabilities.
US regulators also investigated whether Goldman Sachs Group’s asset management division sold ESG funds in violation of ESG metrics.
Are there rules around ESG investing?
Not really. However, regulators are trying to catch up. Under a new law, the Sustainable Finance Disclosure Regulations in Europe, investments must be categorised as “light green” or “dark green” based on their sustainability priority.
Does ESG investing make a difference?
Many ESG academics have expressed dissatisfaction with the strategy’s lack of long-term impact.
The sustainable investment community has taken some steps to address issues such as plastic use, workers’ rights, and compliance with civil rights laws.
The idea that ESG investment alone can solve complex problems has proven to be wrong, say some detractors, and more government intervention is needed to tackle issues such as living wage minimums and greenhouse gas emissions.
On average, ESG large-cap equity funds have done better in 2022 than their non-ESG counterparts.