ESG Investing: Exploring the Challenges and Inconsistencies
A Closer Look at ESG Investing
In recent years, environmental, social, and governance (ESG) investing has gained significant attention and popularity. Investors are increasingly looking to align their portfolios with their values and contribute to a more sustainable and responsible future. However, despite its growing prominence, ESG investing faces numerous challenges and inconsistencies that threaten to undermine its effectiveness. In this article, we will delve deeper into the realm of ESG investing, examining its internal contradictions, the difficulties in implementation, and the need for constant adaptation.
The Internal Inconsistencies of ESG Investing
ESG investing initially appeared to offer a promising solution for investors seeking to support sustainable practices. However, as time progresses, it becomes evident that ESG investing has its fair share of internal inconsistencies. Let’s explore some of the main contradictions within the ESG framework.
1. Reconciling ESG with Economic Realities
One of the central challenges facing ESG investors is the reconciliation of environmental and social values with economic realities. While investors may desire to finance sustainable projects and avoid harmful industries, economic considerations often come into play. For example, recent announcements by the UK government approving oil and gas licenses in the North Sea highlight the conflict between energy security and fossil fuel divestment policies. European banks, known for their green initiatives, find themselves caught between financial profitability and environmental responsibility.
These conflicts create a difficult balancing act for ESG investors, who must navigate the intricate web of economic realities and strive to find a middle ground that aligns with their values.
2. Knowing Where to Draw the Line
Another inconsistency prevalent in ESG investing is the challenge of determining where to draw the line when it comes to sustainability. While it may be clear that coal mining is environmentally unsustainable, the same rationale can be extended to industries that support or enable the extraction and transportation of coal. This includes companies involved in trucking, tire production, and rubber manufacturing, among others.
The issue becomes even more complex when we consider the extensive supply chains associated with businesses. In Europe, upcoming regulations mandate the collection of ESG data from companies along the entire supply chain, irrespective of size or industry. This poses a significant challenge, as the scope of responsibility continues to expand, making it increasingly challenging for investors to determine which companies uphold their desired ESG standards.
3. The Subjectivity of ESG Criteria
Perhaps one of the most challenging inconsistencies within ESG investing lies in the inherent subjectivity of ESG criteria. Different stakeholders may have varying views on what constitutes good and bad practices. This subjectivity makes it difficult to establish standardized criteria for evaluating companies’ ESG performance.
For instance, while there is a concerted effort to exclude tobacco companies from investment portfolios due to health concerns, there seems to be less emphasis on holding food companies accountable for contributing to the global obesity epidemic. This inconsistency raises questions about the prioritization of certain ESG factors over others and the need for a unified and comprehensive ESG framework.
ESG Investing: Navigating Complexity and Adapting
Despite the challenges and inconsistencies surrounding ESG investing, it remains a critical avenue for promoting positive change. To navigate the complexity and achieve meaningful impact, several key strategies can be employed:
1. Robust Due Diligence and Research
When engaging in ESG investing, conducting thorough due diligence and research is paramount. Investors need to go beyond surface-level sustainability claims and delve deeper into a company’s practices, values, and commitment to change. This research involves analyzing a company’s environmental impact, social initiatives, and governance structures to ensure alignment with an investor’s values.
By actively seeking out transparent and accountable companies, investors can distinguish between greenwashing and genuine sustainability efforts, leading to more effective investment decisions.
2. Engaging with Companies and Advocating for Change
Investors have the power to drive change by directly engaging with companies and advocating for improved ESG practices. This can be done through dialogues, shareholder resolutions, and voting at annual general meetings. By actively participating in corporate decision-making processes, investors can influence companies to prioritize sustainability and align with responsible practices.
Furthermore, investing in companies that show a commitment to change can incentivize others to follow suit, creating a ripple effect within industries and driving sustainable transformation.
3. Continual Adaptation and Evolution
ESG investing is an ever-evolving field, constantly shaped by emerging trends, scientific advancements, and societal shifts. To remain relevant and impactful, investors and ESG practitioners must be adaptable and open to change. This involves staying informed about the latest developments in sustainability, recognizing emerging ESG risks, and adjusting investment strategies accordingly.
By actively embracing change, ESG investors can position themselves at the forefront of sustainable investment practices and contribute to the ongoing refinement of the ESG framework.
Conclusion
ESG investing, despite its inconsistencies and challenges, remains a powerful tool for promoting sustainable and responsible practices. Through robust due diligence, active engagement, and a willingness to adapt, investors can navigate the complexities of ESG investing and contribute to a more sustainable future.
Summary
ESG investing has gained popularity in recent years as investors seek to align their portfolios with sustainable and responsible practices. However, ESG investing faces various challenges and internal inconsistencies that threaten its effectiveness. These include reconciling ESG with economic realities, determining where to draw the line in sustainability, and the subjectivity of ESG criteria. To navigate these complexities, investors can employ strategies like robust research, engaging with companies, and embracing continual adaptation. Despite its challenges, ESG investing remains a powerful tool for promoting positive change and contributing to a more sustainable future.
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More than half a decade before its last rebrand, I gave a talk in Berlin on environmental, social and governance investments. Unlike my infamous “Miami Underwater” presentation last year — which stated obvious bleeding, I thought — this one was deliberately provocative.
He warned that ESG (as desired production investment, not input) had an existential problem due to three internal inconsistencies. At the time, I argued that they were reconcilable. Recent events suggest not.
Take Monday announcement by the UK government confirming hundreds of new oil and gas licenses in the North Sea. Whether for reasons of energy security or political expediency, the move now directly contradicts the fossil fuel policies of many banks.
European lenders, in particular, have turned blue in the face trying to balance being green with making money. The most popular ploy was promising not to finance “new” oil and gas fields (rejecting only “new” customers was another trick).
Now these banks will lose a gold mine. They are also at odds with a democratically enforced decision. Harrumph everything you like about US politics this week, but at least America’s approach to energy is in line with banks serving its citizens.
My point is not for funding new oil and gas fields, although in my view the International Energy Agency’s projections are clear that a worldwide path to renewables still requires spending on new fields given that existing ones decrease by 8% per year.
No, what I said in my speech is that moral foundations invariably crumble, mainly due to changes in scientific knowledge, attitudes, money or politics. Even Joe Biden called for America’s big oil companies to start pumping when rising fuel prices jeopardized three congressional elections last year.
In one slide I made fun of a newspaper with the headline “Investment Industry Treason”. The article below was about local fund managers refusing to invest in arms makers on ESG grounds despite the buildup of enemy forces at the border. Then “the tanks entered the east of the land . . . “
War of course is an extreme example of how norms change. Cluster bombs, which are back in the news, have been banned in every stock portfolio I’ve ever managed. But today Ukraine abandons them in the name of freedom. Divestment is suddenly appeasement.
Unless investors can see the future, then, this problem is intractable. Similarly, ESG’s second fatal inconsistency: knowing where to stop. If a coal miner is unsustainable, then so is the truck company that hauls the stuff. And why not your tire supplier or rubber manufacturer? Throw their accountants too.
This is not hypothetical. Next year, for example, European companies with more than 500 employees will be forced to collect environmental, social and governance data on every single company up and down their supply chains.
Yes, seriously. But wait. In 2025, these rules apply if you have a minimum of 250 employees. Then small and medium-sized businesses begin to be drawn into legislation the following year. “Hi Luca! He’s your uncle in Milan. What were your factory emissions in the last quarter? more or less?”
Death by fatuous and incomparable data. And someone has to arbitrarily decide the relative weightings between “E” or “S” and “G”. This is the last inconsistency I raised in my speech: that everyone has their own view of what is good and bad.
Why are huge efforts being made to keep tobacco inventories out of wallets but not the food companies that overload our meals with sugar, salt and saturated fat? Beats me. Nearly half a billion people suffer from type 2 diabetes worldwide. It is among the top 10 causes of death in America.
Or why do we hold companies accountable for diversity and not for work-related mental illness, which makes up half of all days lost to sick leave? Some investors worry about governance, others about homelessness outside their office.
As a result, no one has a clue whether to punish companies like ExxonMobil or reward them for committing to spending $1 billion a year on green energy research. If both, in what proportion? Meta is super green but stinks on “S” and “G,” according to a relationship just published by Internews.
No wonder both companies are in sustainable funds. It’s free for everyone. So much so that only 41% of Europe’s most sustainable ‘Article 9’ products even bother to aim for a minimum 90% exposure to sustainable assets, according to Morningstar data.
Expect class action lawsuits. Wealth managers have already rushed to downgrade 40% of their Article 9 funds just to be on the safe side. It’s probably too late, guys.
Uncertainty has always been the mortal enemy of investments. And few ideas are more inconsistent, and therefore uncertain, than ESG – it doesn’t matter how you brand it.
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