Tariq Fancy: The fairytale of sustainable investing

In Charlie and the Chocolate Factory, a golden ticket opens the gates to Willy Wonka’s mystery enterprise, a fairytale place of infinite dreams and unfettered gluttony. Many see sustainable investing the same way...

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This is part of a series of articles looking at The State of ESG, which will also be the focus of a panel at the forthcoming RI Europe conference, June 14-18

The promise of sustainable investing is the promise of a golden ticket. 

In Roald Dahl’s children’s book, Charlie and the Chocolate Factory, a golden ticket opens the gates to Willy Wonka’s mystery enterprise, a fairytale place of infinite dreams and unfettered gluttony. Many see sustainable investing the same way. For environmentalists and social activists, it's the possibility of big business contributing to a healthier planet and making a more equitable world. While for Wall Street, the untold wealth lies in continuing record-breaking ESG profits. It's the ultimate win-win: doing well by doing good. 

By all accounts, ESG funds are doing well. Extremely well. In the first eleven months of 2020, sustainable mutual funds and ETFs increased by $288 billion. That is no fairytale. But what’s less based in fact is the doing good part. And that's because there's no way to show the real-world impact these funds purport to make. This was something I came to grips with as chief investment officer of sustainable investing at BlackRock, where I helped craft much of the early messaging and witnessed, from the inside, how the industry promotes these extremely lucrative funds. 

The most basic method starts with old-fashioned perception — promoting and publicising funds as making a positive difference in the world and tapping into the public’s desire to do the right thing. This is the fizzy drink that gives sustainable investing its lift. In some instances, investment firms even align themselves with environmental and social causes and organisations to co-brand and push the perception of its ESG values and commitment.

Another method is good grades. Everyone wants a gold star, including Wall Street. But when it comes to ESG, the scores vary from provider to provider and lack clear industry standards. And yet, these ratings give the impression of quantifying the impact these funds are meant to create. That's a myth.

Another industry strategy is to conflate the financial success of the sustainable investing market, or a particular fund, with the success of the positive change it's supposed to make. When industry leaders declare how well ESG investing is doing, with record-breaking fundraises, there's the implicit suggestion that society is benefitting as well. That’s not the case. It means only one thing: the funds are making an enormous amount of money for Wall Street.

But doesn't investing in sustainable mutual funds or ETFs increase funding to environmental and social causes? No, it doesn’t. While the investor may indirectly own more shares in companies with slightly higher ESG scores, those companies don’t receive the new funding. Instead, the money goes to the seller of the shares in the public market.

ESG funds that promise to own fewer shares in polluting companies provide a new twist on the old theme of fossil fuel divestment, the well-intended but naive idea that refusing to own polluting companies stops or even slows down the pollution from occurring. That is a fantasy. Trillions of dollars in ESG funds that tilt toward slightly less exposure to heavy carbon emitters, in the form of 'soft divestment', aggregates into some fraction's worth of de facto market divestment. A recent report in The Economist wrote how the top 20 ESG funds hold, on average, 17 investments each in fossil fuel companies.

And yet, we must recognise that that's only the sideshow since even if those funds did not include the offending firms, they would still have no measurable impact in addressing the climate crisis. And as I wrote in Canada’s Globe & Mail newspaper in March, there is evidence that these funds and the marketing messages around them are misleading the public and lowering the likelihood that governments, who have the systemic tools and democratic legitimacy required to address large-scale crises, such as COVID-19 and climate change, will act.

This would mean that sustainable investing as practised today could even be harmful — serving the interests of those who seek to preserve the status quo through peddling bankrupt 'free market' theories, rather than aiding those who want to see meaningful action to address pressing environmental and social issues.

And when it comes to the social implications of sustainable investing, the conversation becomes even more complicated. The western world has its own set of values that is often not shared with the rest of the planet. Do we impose our values on them through economic pressure? 

But it’s not all doom and gloom. Improved ESG data, disclosures, and reporting standards, though still a work in progress, are a step in the right direction. Europe’s recent clampdown on the definitions of ESG standards is exciting and encouraging. And many long-term, private investment vehicles can and do create real impact. And by far, the most encouraging aspect of ESG is a growing number of mainly young professionals who genuinely care about social and environmental issues. They believe in the promise of sustainable business and ESG standards, even though their hands are tied by a system that rewards harmful but profitable behaviour.

For those of us who care about addressing pressing ESG issues — and not simply generating ESG profits — we need to hold those funds and companies who promote them accountable. If they are going to tell their investors that their funds are better for the planet or better for society, they need to back that up. We need to recognise unfulfilled and unfulfillable promises and not give in to the temptation of perpetuating a fairytale.

Tariq Fancy was formerly BlackRock’s chief investment officer for sustainable investing. He currently serves as founder and chief executive officer of Rumie, a Toronto-based global education technology non-profit.