Behind the ESG label
We all know what organic food is, don't we? Probably not. Although there are legal standards for claiming a food is organic, there are also various voluntary labels, not all requiring certification, which can mean something else connected with the rearing of animals, the growing of crops, the management of soil and so on. We are often eating less 'organically' than we had hoped.
ESG and sustainable investing is facing a similar, confusing future in my view. What will 'ESG' mean to whom and why? In the absence of transparent, agreed standards, it's open to spin-packaging, mis-selling and investor mis-interpretation.
ETHICAL INVESTMENTS
On the one hand, ESG may be interpreted as bringing together the various aspects of a ‘responsible company’, so that those who wish to invest responsibly, for ethical reasons, can do so in confidence. This is, in many ways, an extension of the original 'ethical investments', which were aimed at excluding certain products or industries (e.g. alcohol, tobacco) or focusing on others (e.g. renewable technologies).
This ‘selective-issue’ trend almost takes us back to the origins of ‘ethical’ funds which either excluded or were exclusively focused on certain industries, but without consideration of the wider picture. How often are we now seeing ESG portrayed by some comentators as virtually synonymous with 'low-carbon'? To use the ESG brand for such a sell is quite misleading because it may focus on just one aspect of the E, S or G, and ignore other aspects.
SUSTAINABLE GROWTH
Then, there's the belief that a company following ESG principles will face fewer risks and grow more sustainably. Much of the ESG ratings industry hangs on this premise. However, the ratings depend largely on self-disclosed, annual average, company-wide performance data. Little account is taken of the accumulation of local ESG operational failures and impacts. Corporates do not willingly disclose such data, though it is increasingly exposed on web media.
So we find, for example, that whereas S&P’s rating for Hyundai Motor has improved for the last three years, the NIMBUS risk rating has increased on the basis of ongoing performance which is not reflected fully in the S&P index, e.g. on product safety, treatment of employees and suppliers and employee safety.
S&P ESG Score for Hyundai Motor:
NIMBUS Risk Rating for Hyundai Motor:
FINANCIAL RETURNS
Finally, inevitably, there are efforts to demonstrate that ESG investing actually delivers better returns on a short-term basis. This has involved extensive efforts to find one or more 'ESG' aspects of a company which also shows healthy financial returns - thus establishing the link. Typically the climate/energy metric has been used to uphold this correlation.
Together, these present an attractive proposition to investors, a 'perfect storm': feel good, get rich, invest safely.
It's a persuasive rationale for labelling a fund ‘ESG’, if at all possible. However, this presents a danger that ‘ESG’ becomes a selective label and focuses largely on selected ‘good’ things, like carbon reduction plans, investment in renewables, responsible sourcing of forestry products, biodiversity gain, etc.
ESG standards are emerging and inevitable, and should bring some order to this 'wild west' of investing. However, we should not fool ourselves that the resulting labels will be consistently understood or deliver on expectations.
There should be many lessons to learn from 'organic' food labelling and the plethora of eco, labour and other ethical labels which have emerged for other products. Will they be learnt? Is there one-size-fits all that can be meaningful and useful to all stakeholders?
I somewhat doubt it. As always, buyer beware and know your label.