Sustainable investment has become a hot trend in recent years. More and more investment managers claim to use ESG (environmental, social and governance) factors in their decision making process. However, ESG methods have some fundamental problems. While the intentions are good, trying to achieve too many goals at once leads to conflicts and lack of focus. Regarding environmental factors, the biggest threat is carbon emissions, so metrics should concentrate on emissions alone. With better information disclosure from firms on emissions data, investors and regulators can properly assess companies’ climate impact. Overall, sustainable investment needs streamlining to be truly effective in tackling issues like climate change.
ESG investing ballooned in size but morphed into hype and controversy
In the past decade, ESG investing grew rapidly to over $35 trillion in assets that investment managers claim to screen through various ESG criteria. This explosive growth occurred because more investors wanted to align finances with caring about global warming and social issues. More financial service firms offered ESG research to meet this demand. With governments displaying inertia on these problems, people felt businesses should step up. However, ESG has become shorthand for controversy now. US politicians blame it for inflation. Industry whistleblowers allege deception and greenwashing of clients. Major banks face probes over ESG marketing claims.
ESG jumbles too many goals to provide clear guidance
The first core problem with ESG is bundling together too many goals covering the environment, social matters, and governance. This creates a dizzying array lacking focus. Companies get conflicting signals on what to prioritize. For instance, Tesla’s Elon Musk has awful governance but his electric cars help the climate. Closing coal mines benefits climate but harms local jobs and economies. Building large-scale wind farms quickly can disturb ecosystems. ESG metrics obscure these trade-offs rather than illuminating them.
ESG connection between ethics and profits is questionable
Another issue with ESG is questionable claims that good behavior means higher profits. In fact, businesses externalizing costs onto society via things like pollution often boosts profits if reputation impact is limited. So the supposed link between virtue and financial performance is dubious. Also, the ESG scoring systems provided by various ratings agencies and data providers exhibit inconsistent correlations. Credit ratings show 99% agreement but ESG scores diverge greatly. Companies can game the scoring via maneuvers like selling assets to owners who maintain the status quo.
Focus ESG on emissions data to assess climate impact
For real progress, sustainable investment needs to concentrate on emissions metrics as the key environmental factor. Carbon emissions pose the biggest environmental threat now. Investors and regulators already push for improved disclosure from firms on emissions data. Standardized and transparent data will help assess which companies are large contributors to climate change versus leaders in emissions reductions. Investment managers can better track carbon footprints in portfolios over time. While information alone is insufficient, it helps the public, consumers and shareholders determine who the true emissions culprits are.
In summary, the sustainable investment industry needs to streamline practices and emphasize emission reduction metrics in order to make real progress on climate change. ESG in its current shape provides more hype than help due to internal conflicts between competing ESG goals, questionable ties between ethics and profits, and lack of transparency in emissions disclosure. Investment leaders should focus on pushing firms for reliable emissions data so investors can channel capital toward sustainable businesses.