Several years ago, US Republicans began using ‘ESG’ as an epithet to attack their political opponents. In doing so, they changed the meaning to the extent that in some quarters, the term can no longer be used to neutrally describe specific aspects or styles of investment management practice. Already many organisations have dropped the word from their products, websites, and client communications.
This shift isn’t a bad thing in my opinion since the term has always been wonky and hinders the clarity of communication to broad audiences. I expect the term ESG will go away in the next several years, but the practice of ESG integration will remain.
To avoid any confusion, what I mean by ESG integration is the “ongoing consideration of ESG factors within an investment analysis and decision-making process with the aim to improve risk-adjusted returns” where “an ESG factor is any qualitative or quantitative information pertaining to environmental, social, or governance topics”.
ESG integration is here to stay because ESG information adds value – not necessarily as a factor in a multi-factor risk model (though in some cases it might be) but simply as a factor, or input, in an analysis, recommendation or decision.
See also: – Raising the red card on misunderstood terminology
ESG information provides insights into an issuer’s relationships with its shareholders, employees, customers, the public at-large, and natural ecosystems. The management of these relationships is an important part of managing an ongoing concern, and the quality and condition of these relationships is a reflection of the judgment and abilities of the corporate management team.
The analysis of a company’s interactions with stakeholders and the natural environment has, arguably, always been part of investment analysts’ due diligence, even before the coining of the term “ESG.” What has changed in the last 20 years is that technology advancements in data capture, storage, transfer, and analysis have made it easier for analysts to do deeper and more extensive analysis of ESG information.
Of course the practice of ESG integration isn’t going away, but if the term ‘ESG’ is no longer in vogue, what distinguishing adjective should we use?
Many people are gravitating to ‘sustainable’ as the replacement term for ‘ESG’. This is an improvement in my opinion. The word has a well-defined and established meaning and that makes it much harder for politicians to redefine. However, it has its nuances and challenges as well.
In normal usage, sustainable can mean “persistent” and it has been long used in that way in the investment industry to characterise a growth rate that can be maintained or the level of recurring earnings at the mid-point of a business cycle. However, it can also mean using a resource in a manner such that the resource is not depleted or damaged. The essence of the first definition is simply consistency, whereas the connotations of the second are conservation, stewardship, and perhaps equity.
I worry that people often conflate these two different meanings because they assume, have been told, or want to believe that the sustainable use of resources is positively correlated with sustainable earnings. Such wins-wins are sometimes achievable, but the case for causation is weak.
I think ESG could continue to be used to refer to a certain kind of data. It is less problematic in that context. Some people have tried to characterize ESG data as non-financial, extra-financial, or pre-financial data to convey that the data is different from the data found in corporate financial statements. However, it is hard to explain how “non-financial” data is used to maximize investors’ financial risk-adjusted return.
If I had my way, investment professionals would refer to the evaluation of environmental, social, and governance information as “stakeholder management and corporate reputation analysis.” I think it would be clear what such an analysis is evaluating, that it has value, and it is different from other types of analyses that are pertinent to security valuations, such as financial statement analysis, credit analysis, macro-economic analysis, and industry analysis.
In addition, I would want to see ‘sustainable investing’ seen as particular form of ‘ethical investing’, which could be distinguished from other types of ethical investing by its use of consequentialism – a branch of ethics that focuses on intentions and outcomes..
I realise many people are not so concerned about the precise meanings of words, but it is a lack of precision and sincerity that has allowed ESG to be turned into a political football. Let’s try to avoid that in the future by being careful, cautious and conservative with our words and claims.
