Impact in brief • 3 min read
Once shunned as being too restrictive and hindering returns, ESG (Environmental, Social and Governance) investing has exploded over the last eight years with $425B invested in ESG funds in 2021.
Investors are increasingly questioning the sustainability credentials of funds and in many cases going as far as accusing them of greenwashing, a term used to describe the false branding of something as sustainable.
The spotlight has recently focused on MSCI, the largest global provider of financial analysis indices and ESG rating systems. Analysis of MSCI’s indices by Bloomberg found that they consider 90% of the US S&P 500 index of companies to be ESG compliant. Put another way, only 10% of companies are considered to pose any kind of environmental or social risk.
This goes a long way in explaining how some ESG indices managed to significantly outperform others during 2021, which was an unusually poor year for sustainable investors.
MSCI is not alone. Morningstar, another of the large index providers recently hit headlines as it cut the list of funds that it recognises as sustainable by 27%. 1,600 funds that it had previously considered as sustainable were reclassified.
The move was triggered by European regulators who are becoming increasingly hot on what is and isn’t considered to be sustainable.
ESG risk can be very subjective with many different interpretations which is where the problem lies.
For example, some ESG methodologies might assign a high ESG rating to BP because, relative to competitors like Shell, it has a few stricter policies in place rather than because it is intrinsically a sustainable company.
Companies have built up entire teams focused on improving their ESG scores but they usually focus on the messaging rather than making any kind of operational improvements. They are essentially finding ways to play the system.
Not all sustainable investment approaches should be tarnished with the same brush and there are many companies out there executing sustainable strategies effectively. Often a truly sustainable strategy uses ESG as a foundation to build upon because, as we have just discussed, ESG is a murky world.
If all sustainability minded investors relied solely on ESG we would get nowhere in creating positive change in the world. Understanding your fund provider’s interpretation of ESG and sustainability is critical.
It is about screening out companies that have a materially negative impact on the world, not about seeing which company is doing a slightly better job than the rest.
We think of ESG as a first line of defence to try to ensure no companies with a negative impact on the world make it into our themes. Once we have validated the implementation of the ESG screening and verified the output we can focus on our main pursuit: investing in companies that are positively impacting the environment and society.
Capital at risk.