By Glen Yelton, Head of ESG Client Strategies, North America, Invesco
It only takes a glance at the headlines in the financial media to deduce that ESG investing is booming: Morningstar reports record-breaking inflows to sustainable funds; The Forum for Sustainable and Responsible Investment (US SIF) asserts that sustainable investing strategies account for one out of every three dollars of the total U.S. assets under professional management; even Hollywood has jumped on the bandwagon, with actor Robert Downey Jr. launching a sustainable investment firm.
On the surface, this looks like a wave of noble progress for the finance industry. But in reality, ESG investing is significantly more complicated than many touting the virtues of these investments would have the public believe. Solving systemic societal problems like climate change and racial inequality is not as simple as loading a portfolio with investments that boast favorable ESG characteristics. It’s time for the financial community to engage in a more honest dialogue about what ESG investing really stands for—and what it can realistically achieve.
The term “ESG” is too vague
ESG stands for “environmental, social, and governance.” This framework, while providing a memorable catch-all acronym for a values-based approach to investing, is an oversimplification that gives investors a false sense of standardized criteria and measurable progress. Environmental, social, and governance issues are distinct from one another, and at times, introduce competing priorities. Rather than deploying capital in the service of clear objectives like a sustainable future, improvements to health and well-being, or a more level economic playing field, lumping these issues into a single, broad category muddies the waters. It grants investors a vague sense of satisfaction that their capital is making a difference, without necessarily holding the stewards of that capital accountable for achieving specific outcomes.
Investors can’t do it all
The current discourse around ESG investing exaggerates its potential impact on some of society’s greatest challenges. Consider the example of climate change: the latest report from the U.N. climate panel indicates that human influence has inexorably altered the way our planet’s climate will behave over the next 50 to 100 years. Meanwhile, about one in five of the world’s largest companies has committed to achieving net zero emissions by the year 2050—a factor that contributes favorably to their ESG profiles. This sounds encouraging, until you look more closely at what it will take to mitigate the climate crisis.
The UN Environment Programme (UNEP) estimates annual adaptation costs for developing countries alone at $70 billion (adaptation is defined as “reducing countries’ and communities’ vulnerability to climate change by increasing their ability to absorb impacts and remain resilient”). This figure is expected to rise to between $140 billion and $300 billion in 2030 and between $280 billion and $500 billion by 2050. Meanwhile, the Swiss Re Institute projects that if climate change continues according to its currently anticipated trajectory, 10% of total global economic value will be lost by mid-century. The scale of this problem is simply too vast for it to be resolved in the capital markets. Realistically, tackling the problem of climate change requires resources that only governments and sovereigns can command.
But the construct of ESG investing may give the public the impression that buying a particular kind of investment product will make a material difference in our ability to reverse the course of climate change. In truth, investors play one role in what must be a coordinated, urgent effort between heads of state, policymakers, corporations, and other stakeholders around the world. As my colleague Dr. Henning Stein stated in a recent blog post, “We have to back radical innovation. Policymakers must join a combined effort, provide direction and demonstrate determination.”
Marketing of ESG investments should educate, first and foremost
Asset managers, research firms, and the other players that make up the financial services ecosystem are beholden to their clients—put another way, their clients’ needs are their top priorities. Recently, the demand for investment products that deploy investors’ capital in alignment with their values has skyrocketed. The financial industry’s commitment to ESG is first and foremost about capitalizing on that demand; combating climate change, advancing gender equality, and eradicating systemic racism are secondary objectives (albeit worthy ones).
This is not to say that ESG investing is a total sham or a hopeless exercise. It is to say that the industry needs to be more transparent in the way it markets these offerings to the public. For instance, there is a big difference between ESG integration and ESG outcomes, but this distinction is rarely pointed out. ESG integration refers to the consideration of ESG factors during the process of making investment decisions. ESG integration does not necessarily translate to ESG outcomes—but integration is the metric touted by the industry. To return to the US SIF statistic, one-third of U.S. assets under management may very well be ESG integrated; but the number of products and strategies that invest capital directly toward ESG outcomes is only a small portion of that figure. According to the 2020 Cerulli Associates U.S. Environmental, Social, and Governance Investing Report, only 1.3% of total public market assets represent products that “are orienting their entire investment process and outcome around ESG criteria.”
There’s certainly nothing wrong with the investment industry embracing a more socially responsible approach—there’s also nothing new about it, as socially responsible investing has been around in one form or another for centuries. But the more hyperbole we allow to accumulate around the impact of ESG, rather than leading honest and transparent discussions about what those labels actually represent, the less likely we are to achieve the outcomes today’s investors are so eager to support.
About the author:
Glen K. Yelton joined Invesco in 2019 as Head of ESG Client Strategies, North America based in Atlanta. Mr. Yelton served as the Director of ESG & Impact Investing on OppenheimerFunds’ SNW Investment Team with analytical responsibilities for the Impact strategies. SNW was acquired by OFI Global in 2017. Prior to joining the SNW team in 2015, Glen managed the ESG research program at IW Financial. Before that, he oversaw ESG data collection at American Values Investments. Additionally, he has provided competitive intelligence research for a variety of Fortune 100 clients across several industries and served as an interrogator for the U.S. Army. Glen holds a B.S. from East Tennessee State University.
The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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