Can ESG investing survive the culture wars?

In August 2022, Flori­da gov­er­nor Ron DeSan­tis passed a res­o­lu­tion to ban fund man­agers from apply­ing envi­ron­men­tal, social and gov­er­nance (ESG) fac­tors when invest­ing for the state’s pen­sion funds. The move under­scored a new real­i­ty for ESG invest­ing: it is now firm­ly part of the cul­ture wars. 

DeSan­tis bemoaned ESG invest­ments as using cor­po­rate pow­er to “impose an ide­o­log­i­cal agen­da on the Amer­i­can peo­ple” and accused Wall Street finan­cial firms of employ­ing ESG to imple­ment poli­cies that Flori­da vot­ers had reject­ed at the bal­lot box.

The DeSan­tis play might seem like a parochial US polit­i­cal con­cern and far removed from the sus­tain­able finance land­scape in the UK and Europe. But it’s nonethe­less sig­nif­i­cant, accord­ing to Dr Daniel Kli­er, CEO of sus­tain­able data experts ESG Book and for­mer glob­al head of sus­tain­able finance and group head of strat­e­gy at HSBC. 

ESG invest­ments are fac­ing increas­ing scruti­ny, with indus­try fig­ures like Tariq Fan­cy, for­mer glob­al head of sus­tain­able invest­ing at Black­Rock, ques­tion­ing data reli­a­bil­i­ty in the sec­tor and its promise to deliv­er a pos­i­tive envi­ron­men­tal and social impact.

ESG is “very vul­ner­a­ble” to being co-opt­ed for the cul­ture wars, says Kli­er, in part because the pub­lic doesn’t always under­stand what it is. “Unless we give peo­ple the tools to unpack what E, S and G actu­al­ly mean you will get into these sit­u­a­tions, with peo­ple inter­pret­ing things in a way that may not be intend­ed,” he says.

Kli­er believes this sit­u­a­tion was inevitable, as the indus­try has been over­hyped for some time. “There is no CEO or invest­ment offi­cer speech that doesn’t address ESG,” he says. Now is the right time for the indus­try to grow up, he sug­gests.

“We’ve been through ESG 1.0, which was very much dri­ven by exclu­sion­ary approach­es, such as not invest­ing in coal or fos­sil fuels, and a sin­gle often quite opaque ESG score,” he says. “It’s time for the next stage, where there is real trans­paren­cy and inte­gra­tion into invest­ment choic­es.”

For Kli­er, ESG 2.0 should deliv­er a nuanced dis­cus­sion around what investors are try­ing to achieve, whether that’s a return-enhance­ment strat­e­gy, a risk-man­age­ment strat­e­gy, or an impact strat­e­gy.

New clarity

Simon Raw­son is direc­tor of cor­po­rate engage­ment at Share Action, a char­i­ty which pro­motes respon­si­ble invest­ment. He thinks the polit­i­cal back­lash to ESG in the US has made it a legit­i­mate time to ques­tion what it real­ly means and a good oppor­tu­ni­ty to ensure there is clar­i­ty and trans­paren­cy in how respon­si­ble invest­ment is being pro­mot­ed.

Raw­son notes the inter­est­ing par­al­lel trend among reg­u­la­tors, espe­cial­ly in the EU, who he says are lead­ing the way in pass­ing laws to scru­ti­nise green and ESG ‘wash­ing’. “It’s help­ful as it flush­es out what is real respon­si­ble invest­ment and ensures there are no new mis­selling scan­dals with asset man­agers and oth­ers mak­ing false claims,” he says.

For Kli­er, the public’s under­stand­ing of ESG would be helped by clear­er labelling – a focus for the EU’s Sus­tain­able Finan­cial Dis­clo­sure Reg­u­la­tion – and adopt­ing a more data-dri­ven trans­par­ent approach. 

“If you think about finan­cial per­for­mance, nobody is just inter­est­ed in a firm’s prof­it. They want to under­stand, ‘Is it a rev­enue prob­lem? Or a cost prob­lem? Or to do with the num­ber of cus­tomers?’” he says. “With non-finan­cial data we’re get­ting to the same point – peo­ple want to dou­ble click and dou­ble click and actu­al­ly unpack what sits behind a sin­gle score.”

A more nuanced approach can help avoid a sce­nario where polit­i­cal­ly charged issues dom­i­nate an ESG invest­ment port­fo­lio. “I don’t think this debate ben­e­fits from div­ing into a sin­gle issue and over­stress­ing it,” says Kli­er. “When we think about ESG we think about 450 met­rics for every com­pa­ny and I think ESG, and espe­cial­ly S, works best if you look at it holis­ti­cal­ly.”

Some investors, par­tic­u­lar­ly pri­vate investors, may be very emo­tion­al about cer­tain top­ics, he notes. “Then you can build the­mat­ic strate­gies: for exam­ple, if they want to back com­pa­nies that are led by female founders or to back com­pa­nies that have a bet­ter than aver­age diver­si­ty on the board. But it’s dri­ven by data,” he says.

Raw­son agrees: “If a busi­ness was tak­ing a par­tic­u­lar­ly extreme approach on a social issue which was arguably harm­ful to soci­ety, that would be a legit­i­mate argu­ment for step­ping back, but some of those issues are bet­ter set­tled in demo­c­ra­t­ic debate and our polit­i­cal sys­tem.”

Investor interest

Despite the vocal minor­i­ty in the US, Raw­son says data from real investors show that 95% of mil­len­ni­als con­tin­ue to be inter­est­ed in sus­tain­able invest­ing, while 85% of all investors con­tin­ue to be inter­est­ed in respon­si­ble invest­ing, accord­ing to a Mor­gan Stan­ley study.

He believes the cul­ture wars are a response to the increas­ing polar­i­sa­tion in soci­ety, fuelling insta­bil­i­ty and sys­temic risk with­in the invest­ment sec­tor, but that pan­der­ing and reject­ing ESG fac­tors as a result is not the answer.

“A vast chunk of the wealth that is invest­ed is ulti­mate­ly owned by pen­sion savers and ben­e­fi­cia­ries, who may even have these low-paid jobs. What’s the point of hav­ing a pen­sion that is 10% more valu­able if we’re liv­ing in a world that is inhos­pitable because of run­away cli­mate change? Or in hav­ing a pen­sion pot that is 10% big­ger if you’ve worked all your life on such low pay that your health and well­be­ing has suf­fered?”

Raw­son isn’t con­vinced the cul­ture war dis­course around ESG will spread to the UK. “What we’ve seen from asset own­ers and peo­ple inter­est­ed in respon­si­ble invest­ment is that they can see through this cul­ture war rhetoric and they know that slip­ping back into a sys­tem that sim­ply pri­ori­tis­es finan­cial returns at all costs is exact­ly the oppo­site of what we need at this moment,” he says.

The same debate isn’t occur­ring in oth­er parts of the world, says Kli­er, despite the new pres­sures com­ing through infla­tion and high ener­gy prices. At the same time, the US remains the fastest-mov­ing ESG mar­ket glob­al­ly. “We see the biggest demand in the US mar­ket because peo­ple have realised they’ve missed out on a very impor­tant dimen­sion of their invest­ment deci­sions over the last few years and are try­ing to catch up,” he says.