What effect has the global pandemic had on the trend known as ESG investing? Is it a net plus for the idea or has it actually pushed the concept backwards? If the focus in the coming months is on how to raise growth, create jobs and pay down huge debt, can the world afford some of the ideas associated with ESG? This article examines such points.
Is the pandemic the end of environmental, social or governance-driven investing or a new beginning? It might seem like a bizarre question because the virus has highlighted the importance of food hygiene and the treatment of animals, and how this affects humans. Another concern is accountability – or lack of it – of governments, NGOs, and some private firms. The impact on civil liberties from the lockdowns is another worry, as is the social impact of COVID-19. It has been very different for some people, such as employees of certain firms and governments who continued to work, and those who were made redundant or suffered closures of their businesses. Even so, when the pandemic struck, it did appear, as far as this publication could tell, to put some established ESG themes in the shade for a few weeks. And to be frank, that was possibly not a bad thing. Some of the ESG commentary became stale and needed refreshing.
To discuss what the pandemic means for the ESG approach are Indranil Ghosh and Shelly Goldberg. Goldberg is the founder and principal of Invest-With-Purpose, an environmental sustainability investment management and strategy consultancy. With more than 20 years of experience in structuring and managing portfolios, she runs an environmental sustainability consultancy and investment management practice. Dr Ghosh is an MIT-trained scientist and a sustainable investor, author, and strategic advisor to governments and leading global corporations. Prior to Tiger Hill Capital, Dr Ghosh was head of strategy at Mubadala, Abu Dhabi’s Sovereign Investment and Development Fund, and held senior posts at Bridgewater Associates and McKinsey & Co.
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Five years ago, many people dismissed environmental, social, and corporate governance investing as a fad because it put purpose alongside profit. But today, ESG investing seems to have become mainstream as global flows into sustainable investing are worth upwards of $4 trillion annually. Furthermore, as the COVID-19 crisis mounted in Q1 2020, investors poured $45.6 billion into ESG funds while $384.7 billion flowed out of the overall fund universe.
According to the UN, the funding gap to meet the Sustainable Development Goals is at least $2.5-3 trillion annually in developing countries alone. We think it’s more like $5 trillion globally. Plugging this gap from the public purse would require a 20 per cent increase in the global tax base, which stands at about $25 trillion today. Clearly, this is not feasible. However, steering a small portion of global private wealth, which stands at $200 trillion globally, into sustainable investments could address the world’s development challenges.
Fortunately, investor interest in ESG opportunities has grown steadily as evidence continues to mount that the pursuit of societal benefits does not compromise financial returns. In line with an expanding body of research showing that companies with robust ESG practices outperform their benchmarks, Blackrock’s latest study shows that 94 per cent of widely-analyzed sustainable stock indices outperformed their benchmarks in Q1 2020.
As public attention zooms in on ESG issues due to the COVID-19-induced economic crisis and protests following the killing of George Floyd, many investors are frustrated by the lack of additive impact generated by ESG investing to date. Witness the public backlash against Amazon when it emerged that, despite high ESG scores, many of the company’s US warehouse workers have died from COVID-19 - a tragedy that its employees attribute to poor working conditions.
Problems with ESG investing
Several challenges with the current ESG investing framework have thwarted the impact many investors intended to achieve. First, investment flows trump ESG fundamentals. Approximately 95 per cent of sustainable investment flows are allocated to passive ESG funds that rarely engage with company boards to influence critical changes like carbon emissions or diversity. ESG funds also tend to flow to large corporations which have many alternative sources of capital. But it’s often the multitude of smaller disruptive business at the lower end of the enterprise pyramid - those with direct, pure-play ESG initiatives - that could make the most meaningful impact.
Second, the ESG investors are held back by the lack of standards in measuring and reporting ESG outcomes. While a company may have the right indicators to check the rating agency boxes, it may not achieve the desired outcomes. Combined with the lack of a widely used industry standard for ESG metrics, the door is wide open for corporations to “ESG-wash” their corporate social responsibility metrics. Some heavyweight investors such as Blackrock are rallying behind high-quality reporting guidelines like the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Disclosures (TCFD), but we’re a long way from standardization across ESG ratings.
Third, the universe of active ESG investors - like Trium Capital and BNP Paribas’ Energy Transition Fund, who engage with their investee companies to improve their ESG performance - has been small, albeit this strategy is gaining traction.
Fourth, ESG investing, particularly with its focus on large-cap companies, has often been viewed as a means of influencing gradual, long-term improvement in corporate sustainability practices. However, as the economy is increasingly buffeted by climate catastrophes, pandemics, and other shocks, the urgency for ESG investing to address short-term socioeconomic priorities is likely to be dialed up.