The COVID pandemic and concerns over global warming have raised public interest in ESG investing. The Global Sustainable Investment Alliance (GSIA) has categorized ESG investing into seven themes: impact investing, corporate engagement, sustainability-themed investing, norms-based screening, best-in-class screening, negative screening, and ESG integration.
As of 2020, strategies managing assets worth over $35 trillion were implemented according to GSIA. Insights indicate that global ESG assets are projected to exceed $53 trillion by FY 2025. However, the rising popularity of ESG investing has faced criticism lately. Questions have been raised about the lackluster performance of many ESG funds in the past year, particularly when compared to funds invested in fossil fuel companies unaffected by ESG considerations, which saw record profits during the Russia-Ukraine war.
Let’s analyze 3 major critiques.
ESG is challenging to measure due to the subjective nature of its criteria and the lack of standardized scoring methods. However, ESG investing strategies provide valuable options for investors to manage their assets. These strategies range from targeting impact in specific areas like healthcare, supporting companies that reduce greenhouse gas emissions, to activist funds that push for change in company practices.
Fund managers are responsible for explaining and justifying the benefits of each strategy. Just like there is a variety of investment choices in the public market, there is a spectrum of ESG outcomes offered by different fund managers. It is up to investors to choose the strategy that aligns with their desired outcomes, whether or not financial returns are the primary focus.
Critics argue that better ESG performance does not necessarily lead to superior financial returns, as evidenced by the underperformance of certain ESG funds compared to market benchmarks. Fund managers of such ESG funds should explain any shortcomings in their strategies. However, it is worth noting that in some markets like India, the MSCI India ESG Leaders Index has outperformed the benchmark index over various time periods, indicating the potential for ESG-focused investments to yield positive results.
For many fund managers, a company’s ESG performance serves as an indicator of effective risk management. Companies that excel in managing ESG factors like environmental impact, employee engagement, community support, and governance are likely to navigate challenges such as COVID-19 and climate change more effectively. Insights highlight the superior performance of ESG leaders in terms of core business and financial metrics compared to ESG laggards across different regions.
ESG investing outcomes are not solely tied to financial returns but are influenced by factors like investment duration, business cycles, geopolitical developments, and more. Like any investment fund, the success of ESG funds depends significantly on the capabilities of the fund manager, and expecting every ESG fund to be successful is unrealistic.
Critics argue that ESG investing is merely a form of virtue signaling and lacks genuine commitment to change, citing instances of greenwashing by companies. However, it is important not to dismiss the overall effort to improve ESG performance based on a few bad examples.
As the challenges of climate change and sustainability increase, stakeholders are seeking information through reporting and disclosure frameworks. ESG investing strategies align with these concerns and will resonate with many stakeholders.
In India, regulatory pressure is pushing for improvements in ESG practices. SEBI is urging ESG funds to enhance their corporate engagement and stewardship protocols. The RBI is also taking steps to incorporate assessments of physical and transition risks related to climate change in banks and lending institutions. It encourages these institutions to promote responsible behavior, provide climate-related disclosures, and mitigate risks through measures such as reducing loan tenures for customers facing higher climate risks.
So, the message is clear. ESG investing is not going away and claims of ESG investing’s demise are unfounded.