Will the Backlash from the Right Slow ESG Investing?
A string of Republican-led states have pulled funds from firms that use ESG—environmental, social, and governance—criteria in making investments. Most recently, Oklahoma’s state treasurer announced that “we will not do business with financial companies that discriminate against or boycott our energy industries and businesses.” We asked Yale SOM’s Todd Cort, an expert on sustainable finance, what the political backlash means for the future of ESG investing.
Texas State Senator Lois Kolkhorst questioning finance industry executives about ESG investing at a hearing in December 2022.
Are critics on the political right correct that ESG investments are prioritizing social and environmental concerns over returns?
No. Interestingly enough, critics of ESG on the political left often say that ESG was never about saving the environment or society, but instead is another wave of greenwashing by the finance sector to cover up business as usual—maximizing returns. How can critics be pointing to the same practice and claim that it is accomplishing polar-opposite objectives? The answer is that “ESG” is an umbrella term for many different investment strategies. Some investors see environmental, social and governance factors as material financial risks and therefore their fiduciary duty necessitates that they use ESG information to maximize returns. Other investors will use investment as a tool to drive social and environmental good—noting that this can reduce returns.
ESG, at its foundation, represents an understanding of whether we (and our financial well-being) are at risk because our environmental and social capital is being depleted. The answer, largely, is yes.
What is surprising to me is that by casting generalizations, the critics on both sides are effectively shooting themselves in the foot. By banning ESG considerations for asset managers, critics on the right are reducing their returns. By castigating ESG as greenwashing, critics on the left are losing a valuable tool to create more environmental and social benefit. The truth is that ESG is simply a set of data. Some of it is financially material, some of it is not. Much of it may impact on financial performance, but the relationship is unclear. A productive approach to ESG investing is to understand the investment strategy and make sure that it aligns with your personal values.
Is the backlash against ESG investment a bump in the road or the start of a derailment?
The backlash is clearly just a bump in the road. It is predominantly coming from polarized politics, and mainstream markets and asset managers are pushing forward to deliver on customer expectations—whether that is using ESG data to maximize returns or using ESG data to identify more long-term sustainable investments.
It is also useful to gather a little perspective. Our entire global economy is derived from the conversion of environmental and social capital into financial capital. Resources, clean water, talented people, human innovation—this is what our economic growth and wealth is founded on. ESG, at its foundation, represents an understanding of whether we (and our financial well-being) are at risk because these capitals are being depleted. The answer, largely, is yes. We are using up environmental capital. We are seeing higher inequality and social abuses. So long-term, the foundation of our economy is at risk because our “bank account” is depleting. ESG is our effort to understand how depleted those accounts are.
If an asset manager or company sees ESG as financially material and is focused on shareholder return, but is wary of political backlash, what is their best strategy over the next few years?
Even though the backlash is based on a false premise, it still has real-world impacts. Companies and asset managers may continue to consider ESG factors (that is their duty), but they may leave collaborations trying to solve global challenges because of reputation concerns, or they may stop disclosing their activities in ESG, resulting in less information for us to work with.
For companies in this dilemma, the strategy is two-fold. First, clarify the investment strategy. Make it abundantly clear what ESG data means to you—is it about fiduciary duty, growing your impact, or something else? Pursue one of the emerging certifications on ESG to demonstrate consistency between your investment strategy and investment practices. What companies should not do is take their foot off the accelerator. ESG risks are real and increasingly present. Ignoring them in favor of political expediency is a recipe for disaster.
Second, focus on standardization. Standardization of ESG metrics and data allows comparability and this will be key to overcome confusion and conflict. There are a variety of efforts to standardize ESG metrics, including accounting standards, auditing standards, risk assessment standards, and emerging regulations on disclosure. Companies should engage in these processes to be ahead of the curve and to better understand where ESG might prove valuable.