The explosive growth of environmental, social and governance investing in the past few years is creating tensions that could make life more complicated for money managers and investors alike.
For decades, investors who were passionate about certain causes mobilised around the idea of 'socially responsible' investing, in the hope of using their financial might to help bring about changes they believed were worthwhile.
But in the past few years, as the inevitability of climate change has shaken business and government leaders around the world, investors have been piling into ESG portfolios at a breakneck speed. A record $350bn (£247.6bn) flowed into ESG funds in 2020, according to Morningstar.
In theory, putting money into climate-friendly companies and moving away from carbon-intensive industries seems like a 'can’t miss' solution. ESG investing, like socially responsible investing before it, suggests a world of 'good' and 'bad' in which good people invest only in the good things and are rewarded with good returns while clearly harmful industries like, say, tobacco suffer.
But climate is not tobacco. Companies that might seem bad today because of their carbon emissions might also be essential cogs in the global economy (energy producers or airlines for example), and could be on their way to a more sustainable future. Casting them aside now could be counterproductive or even foolish.
The wide range of ESG issues, the variety of circumstances that different companies face and responses they make, and the simplifications and biases inherent in the metrics as well as in investors’ minds, all make the reality of ESG investing much more complex than the feel-good messaging around it suggests.
There are five inherent tensions that providers of ESG products and investors need to be mindful of.
1. Difficult trade-offs
Even the best sustainability approaches involve grey areas in which the pursuit of one goal could compromise another. Sometimes there are tensions between the E or S agendas: the Financial Times reported last December, for example, that the construction of Tesla’s German gigafactory for electric vehicles in Europe had been held up by environmentalists’ concerns over sand lizards on the site. Likewise, nuclear power offers the zero carbon emissions energy the world desperately needs, but also brings concerns about waste.
Sometimes the tensions are between the S and G. In February the Financial Times reported on the “dark secret” of sustainability: that ESG investment favours tech companies that often minimise their tax liabilities. In any tax system that seeks to penalise undesirable behaviours and reward desirable ones, acting in a more desirable way will, by design, save tax – but the extreme tax position of the big tech companies, combined with their heavy weighting in ESG indices, creates an unintended social consequence.
2. Balancing inclusion and exclusion
Increasingly, the goals that people seek through socially responsible or ESG investing cannot be achieved by divestitures alone. In ESG there is not one clear-cut set of categories to divest from and another to invest in. In total, there are 17 sustainable development goals defined by the UN, focusing more on any one of them would shape a different set of investment priorities.