The End of ESG Investing?

In short:

  • ESG inflows have slumped globally by 36% in the first quarter.
  • Integrated ESG policies could allow a firm to obtain a competitive advantage relative to other industry players.
  • It will most likely stick around, although it will continue to be well-debated.

A record of $649 billion flowed into ESG-related funds worldwide in 2021, and it now accounts for 10% of worldwide fund assets. Especially investors concerned about climate change and social justice are urging companies to alter their funds emphasizing ESG issues. The term ESG is less than two decades old and has gained tremendous popularity in the asset management industry. However, recently, skepticism towards the term has grown and some worry it is losing its credibility – Is it here to stay?

Defining ESG

It might be helpful to briefly define the ESG framework first. Environmental, social, and governance, or simply ESG, are standards for a company’s behavior used by investors to screen investments. It is an approach to assess the extent to which a firm works on behalf of social goals that go beyond the role of a corporation to maximize profits on behalf of the company’s shareholders.

Environmental criteria reviews how a company safeguards the environment, such as policies concerning climate change. Social criteria assess how a corporation manages relationships with everyone involved, including employees, customers, and suppliers. Governance concerns leadership, pay audits, and shareholders' rights.

Why is it important? Until recently, many investors never took into account the impact the holdings of portfolios could have on the environment, society, and communities. Primarily because the priority has been given to profit and gain. However, due to the underlying concerns and pressures concerning sustainability, change is gradually taking place and more emphasis is being laid on ESG factors.

So, what's the problem right now?

An organization’s dedication to achieving the greater good – sounds pretty rosy. ESG has become increasingly broad providing approaches to investment that present strategies that assure bring about positive social or environmental change. The benefits of ESG investing are, therefore, often highlighted. However, one concern is the unclear definitions of ESG, which along with high demand, leads to green investment products that are…actually not that green after all. Especially regarding environmental credentials, companies and investors ‘greenwash’ or might make misleading claims. Not only big names but also retailers are looking under the hood of the ESG industry and questioning if it is worth it. For them, ESG factors are directing their savings and they are not particularly content with the results, as they wonder if it has any effect at all.

In the last years, the demand for ESG had significantly increased, attracting large amounts of funds. However, now, the demand has dropped and ESG inflows have slumped globally by 36% in the first quarter. As seen in figure 1, after more than three years of inflows, US ESG equity funds are experiencing a record month of outflow in May, of nearly $2 billion.

Figure 1: ESG fund inflows and outflows

Source: Bloomberg Intelligence

In addition, the impact of Russia’s invasion of Ukraine forces companies, investors, and governments to grapple with developments that pit the E, S, and G against one another. According to Hubert Keller, managing partner at Lombard Odier, the war is testing the world of ESG, and it leads to the question “what is ESG exactly? Can we afford it?”

So, is it here to stay?

Even though the ESG inflows have dropped this month and perhaps the term is losing its credibility, a strong ESG proposition might allow long-term company growth and indicate how advanced companies are with sustainability. The positive effects of the ESG framework might be quite intelligible; the companies are responsible stewards of the environment, good corporate citizens, and led by accountable managers.

The possible societal effects might speak for themselves, however, McKinsey stated that ESG is here to stay and that for companies, a better ESG score also renders to nearly 10% lower cost of capital due to risk reduction.

On top of that, according to Nasdaq, ESG practices can benefit companies and investors in many ways, one of them being unlocking competitive value. Firms would be better able to recognize strategic opportunities when adapting to changing socio-economic and environmental conditions; they state that this way, companies would be able to meet competitive challenges. Integrated ESG policies could thus permit a firm to obtain a competitive advantage relative to other industry players.

Lastly, when it comes to environmental concerns, many are frustrated that the significant green investments are not paying off, and not leading to a notable reduction in global carbon emissions. However, this extensive flow of funds commenced only recently, and we have to keep in mind that a considerable industrial, agricultural, and economic change would not occur in merely less than a decade – it might take a while.

So, will it stick around? Probably. Although the term ESG has received some criticism, especially amid recent greenwash allegations, it might not disappear soon and will continue to be well-debated.

Link 1    Link 5
Link 2    Link 6
Link 3    
Link 4