A month ago I clearly hit a nerve by posting a short commentary on LinkedIn entitled Is the green veneer of ESG investment starting to crack? It had more views than anything I’d posted previously and plenty of comments – mostly supportive – so I thought it would be appropriate to dig a little deeper into what is a very broad and du jour topic.
Let’s start with some positives. Environmental and social (the E&S of ESG) issues are everywhere right now. From advertising campaigns to supermarket shelves, Netflix to politicians clutching nervous bunny rabbits, it seems like everyone is trying to make the world a bit better. This is A Good Thing. And when it comes to investment, Bloomberg recently published an article entitled ESG assets may hit $53 trillion by 2025, a third of global Assets Under Management, which strongly suggests that a lot of asset owners want to do something a bit more responsible with their money. Which is also A Good Thing.
In fact, if a third of assets will shortly be ‘ESG assets’, surely that means some meaningful proportion of the world’s businesses are also moving in the right direction?
Well, not so fast.
An August 2020 study of US equity funds by Barclays found that whilst “growth has been driven by interest in sustainable investing rather than superior performance” unfortunately “ESG-labelled funds do not necessarily provide more ESG exposure” than conventional funds. In March this year Hargreaves Lansdown was lambasted for promoting as a positive the fact that a tobacco company and a mining company are the third and fourth most highly ESG rated companies in the FTSE 100 (based on Refinitiv data). And then Tariq Fancy, the former Chief Investment Officer of Sustainable Investing at BlackRock, summarised it all by saying that: “In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.”
So what’s gone wrong? In a word (OK, several words), complete and utter misalignment between what ESG actually is and what most people think, or are being told, it is.
Going back to its roots, ESG is fundamentally about risk and materiality. Future-Fit’s Chair of the Board, Paul Clements-Hunt, was running the UNEP Finance Initiative in the early 2000s and was part of the conversation that first created the ‘ESG’ acronym. In his own words:
We were looking to engage the investment chain in discussion around the materiality and the fiduciary duty associated with environmental, social and governance issues. ‘ESG’ was intended to be a lens whereby we could engage with the investment sector to account for these critical issues.
That’s a worthy aim and arguably it has been extremely successful, at least to the extent that it is pretty much untenable today for an investment manager to not even consider ESG issues (even if they don’t then do very much with those considerations). However, it is most definitely not the same as actively investing in businesses that are trying to make the world a better place, or even avoiding those who are making it worse.
And that’s the nub of the problem. ESG, sustainable, responsible, ethical, green are all words being used interchangeably to mean everything and nothing. There are formal(-ish) definitions, but the average saver is utterly unaware of them. The implication is that your money is helping to save the world; but mostly the promises are empty. It’s a bandwagon that everyone is jumping on. I hear something along these lines every week from people I know inside the industry:
Every new capital raise meeting starts by someone asking ‘What’s the minimum we need to do to label this a Green Bond?’
This makes me really angry.
Millions of individual investors are being led to believe that they’re doing something meaningful with their pensions and savings, when in the vast majority of cases they’re not. That’s bad enough in itself. But even worse, we’re missing a huge collective opportunity to improve the future. Investors are being duped at best, lied to at worst. Tariq Fancy likens it to “giving wheatgrass to cancer sufferers”.
Despite all of the on-stage pontificating and annual letter writing, the investment industry has been found to be lacking sufficient integrity, so now the regulators are stepping in. The EU Taxonomy and Sustainable Finance Disclosure Regulation are, in my view, a very welcome step in the right direction. No such government-driven initiative will ever be perfect, but it’s a very real warning shot across the bows that greenwashing will no longer be accepted. I trust many other geographies will follow suit quickly. As Paul Clements-Hunt suggests, there’s good reason to:
There is an ESG bubble and it’s about to burst. Then there will be a move to ‘Real ESG’, which will be embedded into the very fabric of institutions and their offerings. Any institution doing ‘ESG-lite’, and sticking with the greenwash, runs a very significant reputation risk.
Defining what funds must do to claim that they are ‘sustainable’ enables underlying asset owners to cut through the noise and be sure that their money is at least trying to have a positive impact. Furthermore, ‘ESG integration’ can be freed to revert to its original meaning of examining related risks and opportunities through an investment lens. (Side note: can someone please come up with something more marketing-friendly than “Article 6, 8 and 9” funds?)
A large part of my motivation for founding Future-Fit was to enable significantly greater transparency as to the impact of any portfolio, and thereby facilitate the flow of capital toward creating a genuinely brighter future for us all – in complete alignment with the aim of these regulations. I believe that with the Business Benchmark we have succeeded in creating the most rigorous approach for doing this today, and are in the process of refining our portfolio analysis methodology with Development Council members Regnan and WHEB (both managing funds in the ‘Article 9 – having a sustainable investment objective’ category, here and here). We will publish more on this methodology in due course, but if you’re an investor and would like to know more then please don’t hesitate to reach out to me.
I see a growing wave of investors who want to use their money for more than just financial returns. We collectively understand what business needs to do to play its part in creating a world without poverty, hunger, climate change and injustice. We must move swiftly to enable the former to empower the latter, in complete honesty and transparency. The cost of failure is unthinkable; the upside of success is (almost) unimaginable.
I’ll leave the final words to Paul Clements-Hunt.
Through the ESG materiality lens the investment chain will understand better the manifold systemic and converging risks, but it also opens forward-looking investors to the greatest investment opportunity in history – namely re-wiring the planet, our cities, our systems in a way that works for all and empowers sustainable value creation.