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Am I getting cynical about ESG investments?

In a previous blog, I explained why I changed my initial view on ESG: it is not just a marketing hype. There is evidence that the investment industry is serious about it. The regulators are also demanding more on data standardisation and ESG disclosure, both for individual companies and for fund managers.

But it seems that many advisers in the UK are still cynical about ESG investments. See this recent survey reported in the press:

More than two-thirds of advisers are worried about being caught up in the fallout if they recommend products that are not as green as they are marketed as, with 20% saying they are ‘very concerned' about the risk and a further 49% admitting they are ‘somewhat concerned'. – Professional Adviser, 8 September 2021

In response, I ran a poll on LinkedIn. Specifically, I asked “What prevent advisers from recommending ESG investments to clients?” We all know that LinkedIn polls are not very scientific and have sample biases. Nevertheless, the findings – and the comments – give some interesting perspectives. And I must admit that I share some of their sentiments.

The one with most votes was “uncertainty on long term performance”. This topic was also mentioned a lot in the media recently. For example, the former global head of sustainable investment in Blackrock criticised fund managers as not being truthful about the performance risk of ESG investments. We have also read high-quality discussions on the economic rationale of why long term performance of ESG investments may not be as strong as what fund managers claim[1].

Fundamentally, investors invest to make returns over time in order to meet their financial goals. Advisers are right to consider whether ESG investments meet such functional needs. But the discussion on performance potential often gets strange. The sceptics kept quoting empirical research on why ESG is a waste of time. Advocates hit back with other research evidence. Some even questioned the moral integrity and ideological biases of those who doubted that (see an example here).

A critical look on performance potential on ESG is what professional investors and advisers should do. We do the same for other types of investments. It is possible that the debate can keep going on, just like the active versus passive investments debate. What is important is being critical, but open-minded. also It is worth remembering that while return potential is important, clients have other reasons, like ethical, emotional and expressive needs, that drive their demand on ESG investments.

The second most voted concern is greenwashing. This concern is shared by the broader investment industry and regulators around the world. They all want to standardise reporting of ESG data. But that also leads to two inadvertent consequences.

First, there is an over-emphasis on using measurable data when not all ESG aspects have data or can be measured quantitatively. Is the wealth gap a good measure of how a country is doing on S? If the narrowing of the wealth gap comes with an increase in human rights abuse, is that really a good S?

Secondly, the attempt to standardise results in a wide array of possible measures that one can use in screening companies. That is fine if these different measures produce broadly similar results. But that is not the case. For instance, an interesting research from Germany showed that different measures of carbon risks can lead to different selection of companies in a portfolio, with very different performances as a result.

Advisers’ concerns on greenwashing also relate to the investment process used by fund managers in their ESG products. The labelling of the fund could also cause confusion. An investor looking for impact investment may end up with an ESG fund that is managed using exclusion of non-ESG compliant companies. Minimising the likely mismatch in a fund’s investment objectives with investors’ expectations is one that the industry needs to help advisers with.

After seeing these (albeit unscientific) poll results, have I changed my mind about ESG again? The answer is no. As an investment professional who looks at complex investments, I have always been critical of any investments that are presented to me. However, that does not defeat the fundamental reason of investing in a specific asset class or strategy, even if I need to work harder to find the right one for clients. For ESG, I still believe that allocating your capital for good is what all investors should aim for. But I would continue to apply my critical (and maybe, also cynical) lens to look at what is available out there. I would also use such a critical approach to build the right investment selection process.

James Chu CFA

Head of Investment Solutions

[1] This was covered in detail in one of our Monthly Insights. Please contact us for a copy.

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