Despite its popularity, there’s still plenty of misinformation out there about ESG investing, what it is and is not. Here are seven of the most common myths.
ESG requires you to sacrifice returns
Because ESG strategies sometimes provide lower absolute returns compared to otherwise equivalent traditional strategies, there is a widespread misunderstanding that sustainability considerations are harmful for investment performance.
What we at EBI believe investors should really be concerned with is the amount of return their investment generated per unit risk they took on.
ESG investment is about reducing exposure to a range of risks associated with environmental, social and governance issues. For example, companies which release higher volumes of greenhouse gases might be able to produce higher revenue in the short term, but are more at risk of regulatory intervention and changing consumer expectations over time.
Similarly, corporations with poor board structure and a lack of accountability might perform well according to a quarterly financial report, but are inherently at larger risk of mismanagement, scandal and corruption. Thanks to the risks that sustainable strategies manage to avoid, the returns per unit risk are often stronger than those offered by non-sustainable investments.
ESG is just greenwashing
A times, there’s a been a lack of trust between investors and asset managers. Investors have felt that they’re just being sold a product that looks ‘green’ for the purpose of selling it.
Undoubtedly, greenwashing still exists, but there are now far stricter regulations in place governing asset managers’ and companies’ conduct.
For example, in the UK there are the FCA’s Sustainability Disclosure Requirements (SDRs) and its associated investment labels, which require asset managers to clearly categorise funds according to their sustainability credentials and evidence any ESG claims they make.
The FCA have also introduced a specific anti-greenwashing rule which requires that all sustainability-related communications are fair, clear and not misleading.
In short, it’s now more costly than it’s ever been for providers of investment products to bend the truth about a product’s sustainability. Investors should feel reassured that this has been identified by various regulatory bodies as a problem in the past, and that significant work has been put into policing and disincentivising it.
ESG means the blanket exclusion of whole industries
ESG is not about mindlessly removing whole industries, or markets, instead it’s traditionally been about leaning away from the least sustainable companies and the least sustainable business models in favour of those which are more sustainable.
For example, EBI’s Earth range screens out those companies which earn higher than threshold percentages of their revenue from coal mining or unconventional oil and gas extraction (amongst others), but that doesn’t mean it doesn’t still allocate to major energy companies like Shell or Exxon Mobil.
More and more, ESG implementation is also about engagement – investing in companies that don’t have perfect ESG scores and then working with them as an activist investor to improve their sustainability.
A large part of ESG today is active ownership (not to be confused with active investment management!), and we believe this is now a core part of what it means to be a sustainable investor.
ESG is dying under Trump
It’s undeniably true that President Trump’s election to the Oval Office has been a headwind for anything he considers inconveniently ‘green’ or liberal, but the long-term influence of his tenure on sustainable investment has been overhyped. Firstly, because the presidency is a temporary phenomenon.
The US midterm elections are coming up in November, and the GOP may well lose seats according to recent unfavourable polling, which would make it harder for his administration to continue to legislate against sustainable development.
Even if the midterms do swing towards the Republicans, his presidential term is approaching its half-way mark already. Sustainable ideology will outlive Trump’s time in power. In the long term, it’s ultimately market forces which will dictate where capital flows.
Trump’s political concerns may also end up being compounded by an energy crisis over the coming months because of the closure of the Strait of Hormuz, and there may well be a political backlash against the refusal to facilitate and encourage sustainable energy growth in the US. American’s care deeply about the cost of living, of which energy bills are a large part.
More broadly, ESG’s progress is not driven solely by the US. Contrary to popular belief, it’s actually China that has cemented its position as the green capital of the world in terms of the climate technology and scale, even though it remains one of world’s largest polluters.
The UK and EU have led the way in pushing forward regulation like SFDR and SDR, and both are continuing to embed sustainability into financial rules. Though Trump may have lost America ground in the race for leadership in the sustainability space, the race itself is gathering momentum all the time.
ESG is all about ethics
ESG is not all about ethics, it’s about returns, and the risk that investors need to take on in order to achieve those returns. That’s not to say that it doesn’t also align with practices which many people consider to be ‘good for the world’, just that it’s not predicated upon ethical restrictions or requirements.
Consider the actual word ‘sustainability’: at its core ESG is all about investing in companies that are expected to be long-lived, and flourish throughout their lifecycle.
Consider a company that pollutes its local air and water, that doesn’t adhere to labour standards or care about its employee’s rights, and that suffers from groupthink amongst its board members, how is that company going to perform over the coming decades?
It’s common sense, not moral superiority, that dictates that it won’t be in a position to thrive. ESG is about leaning towards those companies which will naturally build and grow under the conditions of the 21st century.
SRI and ESG mean the same thing
SRI and ESG are not the same thing – SRI is more values-oriented than ESG, which is exclusively about using risk and return to your advantage. SRI still prioritises financial returns, but there are also values filters involved.
SRI strategies often utilise positive screening, or so-called ‘hurdles’, based on value judgments. Fund managers allocate to the best-performing securities within the universe of remaining companies once these hurdles have been applied. SRI still prioritises financial returns over real world impact, but it is also more philosophically driven than ESG.
There’s no way to quantify the difference you’ve made with impact investing
Impact investing goes further than either SRI or ESG investing – it’s about prioritising real world positive outcomes alongside financial returns. Often investors will invest in ‘green’ funds with vague notions that their money is being put to good use, without ever becoming aware of the actual real-world consequences of their investment.
That’s not what impact investing is about. Rather, it is about setting specific, measurable outcomes, having key performance indicators to measure the success of those objectives, investing the money as sensibly as possible, and then measuring success after a period of time.
Measurement can be done both quantitively and qualitatively, but it’s the quantitative KPIs that really move the needle in terms of considered success.
Over the coming years, we would like to see a broader understanding in the retail market of how impact is measured, we think it’ll encourage enthusiasm and involvement.
Investors should expect their impact investments to be returned with specific data that lets them know the scale and scope of the impact they’ve had.
Read more: Investing in megatrends changing the world
