I’m troubled. For nearly fifteen years I’ve made my living from ESG. I’ve lived through the ups – when we thought ‘reputation risk’ was the magic key to winning over the ‘mainstream’; then it was ‘materiality’; then ‘universal ownership’; then ‘long-termism’. One slogan and buzzword after another, really. And the downs – the almost instantaneous return to business-as-usual after Deepwater Horizon, Marikana and the worst financial crisis in decades. Have we achieved anything? Surely we’re doing something wrong? Surely there must be another magic bullet we can try?
I’m starting to worry that the biggest problem for ESG people is, well, ‘ESG’.
By this I mean the tendency to make ‘ESG’ a ‘thing’ to be promoted, looked for, and ‘integrated’ – sometimes forced – into every part of a portfolio and every investment strategy. And then reported on. (Reporting separately on something that is supposed to be ‘integrated’. Am I missing something here?) It sometimes feels as though we’ve invented a hammer and now we’re desperately looking for nails to hit with it.
To me ‘ESG’ is not so much a ‘thing’ as a way of thinking, derived from the underlying E/S/G issues, and from more besides. E, S and G are connected at a certain level, of course, but they very quickly disaggregate into widely differing drivers of things that matter to companies. From this perspective some of the best examples of ‘ESG integration’ I’ve seen recently have been in the practices of investors – portfolio managers at asset management firms and asset owner institutions – who are at best puzzled by questions about ‘ESG’ and at worst hostile to them. They speak the language of structural changes in markets, resilient business models and high barriers to entry, long-term reliable cash flows, etc. – not of ‘ESG’ (sometimes they talk about ‘sustainability’ – though more in the sense of sustainable business franchises and earnings than climate change, resource scarcity etc.).This brings us to a paradox. We ‘ESG people’ hunt for ‘ESG’. We want it to be visible. If we can’t see it, we assume it’s not there, and that the fund manager in question is a ‘laggard’ to be ‘engaged with’. Asset owners tell asset managers they want it. Asset managers ask asset owners to tell them what it is they want. Asset owners look uncomfortable and say it’s up to the asset managers to identify the material issues. Meanwhile companies ask investors – and that’s the asset managers – what the material issues are for their business, and the investors say it’s up to the directors to run the company and identify the material issues.
Yet it may be that ‘ESG’ is so elusive and invisible precisely because it’s in fact being done really well. Or perhaps we’re looking for the wrong thing. There’s no ‘ESG’ to be found (horror of horrors, they don’t have five alternative ESG ratings for every stock in the portfolio!) But if we looked from a different angle, we’d see a high-quality fundamental research process, a long-term investment horizon, low portfolio turnover and deep understanding of the companies held.
At the same time, of course, behavioural biases (not to mention gaps in professional training, incentives for short-termism in the investment chain and more besides) may mean that not all potentially relevant E/S/G information is brought into the investment process unless it’s made explicit – which takes us back to the ‘quest for visibility’. Perhaps we need to ‘de-integrate’ – i.e. separate out the ESG to prove it’s there – before we can ‘re-integrate’ it (i.e. address it as a core, ‘normal’ part of the investment process).
There are many dimensions of the responsible and sustainable investment world that don’t take this ‘ESG as a thing’ approach, of course – e.g. allocating capital to sustainability solutions, and issue-specific analysis and engagement.
And the codification of ‘ESG’ has enabled us to make great progress – in raising the profile of neglected issues, gaining the attention of the world’s largest asset owners and fund managers and developing a strong body of analysis, evidence and practice.
But we need to avoid being stifled by our own creation. ‘ESG’ is a means to an end (sustainable capital markets), not an end in its own right. We need to recognise that sometimes the hammer will not have a nail – sometimes ‘ESG’ might simply not be ‘material’ in a particular investment context. What we’re really trying to do is not promote ‘ESG’. It’s to encourage better, more holistic, longer-term investment processes that are in synergy with powerful environmental, social and economic forces that are shaping markets and businesses and which are often (albeit not always) overlooked by investors.These include ‘planetary boundaries’ linked to climate change and resource use; the social priorities of human rights, fairness and democracy; and the imperative to provide decent retirement incomes to rapidly ageing populations.
As Franklin D. Roosevelt might have said to ‘ESG’ people, “you have nothing to fear but ‘ESG’ itself”.
Rob Lake is an independent responsible investment advisor, formerly at PRI, APG and Henderson Global Investors
Footnote, from Wikipedia: ‘Aunt Sally is a traditional throwing game… An Aunt Sally would be “set up” deliberately to be subsequently “knocked down”, usually by the same person who set the person up.’