Over the past decade, environmental, social, and governance (ESG) investing has crossed the chasm from a niche asset management strategy to a mainstream investment. In fact, over the past 8 years, products bearing the ESG label have more than tripled and are expected to exceed $41 trillion globally in 2022. It’s clear that ESG investment approaches and products are here to stay and represent an enormous opportunity to put capital to work addressing our social and environmental problems. That said, ESG investing is not without its challenges. Greenwashing, data inconsistency, performance challenges, and the difficulty in measuring impact are key criticisms facing ESG products and providers.

In a recent panel, hosted by Confluence Philanthropy, I had a chance to discuss these opportunities and challenges with Kristin Hull, Founder and CEO of Nia Impact Capital; Amy Orr, Director of US Shareholder Engagement with Boston Common Asset Management; and Lily Trager, Managing Director and Head of Investing with Impact for Morgan Stanley. Our conversation anchored around four key discussion items.

1. Not all ESG approaches are created equal.

   The beauty of ESG is that it is endlessly customizable to meet the needs of a diverse set of investors. Herein also lies the challenge – every ESG fund and index captures a different set of inclusions / exclusions. For example, the S&P Dow Jones Indices removed Tesla from the ESG version of their Index, yet Exxon Mobil remains. This means that investors need to look beyond the ESG label when making a decision about whether to invest – digging into the underlying data behind the products and indices to understand the methodology and approach before making an investment decision.

2. ESG has gotten political.

   ESG has been the subject of a number of high-profile critiques; from Mike Pence authoring an op-ed in the Wall Street Journal calling on Republicans to stop the ESG political bias, to Elon Musk calling ESG a “scam”, to the Financial Times’ US Finance Editor Robert Armstrong saying that the “ESG Investing Industry is Dangerous”.  Advocates of ESG celebrate this as an inevitable result of ESG going mainstream and having an effect. ESG tends to tackle big, important issues, and putting ESG strategies under a magnifying glass is one indicator they are gaining traction.

3. ESG fund performance hasn’t kept pace with peers.

   One of the main critiques of ESG is that investors are paying a performance premium by investing in ESG. Let’s look at what has happened in early 2022. ESG funds, which tend to be underweight in energy stocks, have underperformed their more traditional counterparts because they lost out on the gains resulting from rising energy prices. Proponents of ESG argue that this type of short-term volatility is no different than what you might experience with any other asset class or investment approach. In fact, the shift toward a net zero future (where the amount of greenhouse gases going into the atmosphere equals the amount removed from the atmosphere) means that by positioning portfolios to capitalize on progress in core areas, we believe ESG investors should be well positioned to capitalize on this trend over the long term.

4. ESG is both too aggressive and not aggressive enough.

   Larry Fink, once an outspoken advocate of ESG, has said that BlackRock will likely vote to support fewer climate proposals than it did in 2021 – taking aim at some investors for attempting to micromanage companies. On the flip side, impact-focused investors have criticized ESG for not generating enough direct impact. Our panel agreed – we aren’t going to get out of the social and environmental problems we’ve created by relying on the same shareholder-centered capitalism that helped create them. Rather than micromanagement, investors are seeing that they can invest with ESG funds that actively represent their values at the corporate level. And while there is little direct impact through public investment or divestment alone, long-term shareholder engagement campaigns can allow impact investors to move the needle on issues at some of the largest companies in the world.

While no investment approach can address all of our problems, ESG investments can play a key role in both raising awareness and allowing investors to actively work to re-shape the path that helped contribute to the challenges we’re fighting against. The more investors and advisors embrace ESG, as well as impact investing strategies, the better positioned our community becomes to use capital to help drive meaningful change.

- Jesse Simmons, Managing Director, Research & Advisory, CapShift