There are a lot of acronyms on Wall Street. One of those acronyms that has become a bit of a buzzword lately is ESG: short for environmental, social, and governance investing. E,S, & G are additional factors/drivers/issues for which to screen investments. When I started in banking I might not have been able to tell you what all three letters stood for at once. I would have probably said “it’s like impact investing, but institutionalized.” ESG was just not a part of my daily investing language; clients didn’t ask, and if they did, there was little we could offer them.
Now in my day-to-day, it is. But during a few recent conversations, when I employed the acronym by habit and was asked to define it, I began to think… what is ESG exactly? And as I started to write it out, I realized the definition is a lot more than reciting the terms full form.
ESG was coined by the UN in 2005 under the guidance of then Secretary-General Kofi Annan (side note: I met Kofi at a luncheon in grad school in 2012. When I told him I was studying finance he smiled and said “good, we need more financial professionals who understand policy.”) Having convened institutional investors, asset managers, research analysts, and government representatives, it was agreed that investment had a major role to play in building more sustainable societies. But despite almost uniform agreement on the importance of these factors, ESG didn’t become immediately mainstream for a variety of reasons.
At the time, members of the UN working group expected ESG investing principles to become widely adopted within five years. What they didn’t expect was the 2008 financial crisis, which set the ESG movement squarely on the back-burner, as world leaders dealt with the fallout in global markets.
Furthermore, since investing has always been about the balance between financial risk and returns, ESG’s desire to deliver returns on additional factors initially gave investors the impression that there was going to be a trade-off: you had to give up some of the investment returns to drive positive social and environmental outcomes (I touch on this issue a bit here).
While this initial impression has now been debunked in a variety of ways, it underscores the fact that ESG suffers from a data problem. Until recently, reliable data wasn’t available to either refute or support the claim that ESG investments underperformed; metrics were subjective or fragmented. It is also just not that easy to measure environmental and social factors. Only recently have corporations begun releasing their carbon footprint, or tracing the social impact of their entire supply chains, for example. Innovation in ESG data measurement and analysis is much-needed.
ESG also has some close cousins in terminology, which conflate investor confusion with lack of demand. From impact investing and socially responsible investing (SRI), to sustainable investing and UN Sustainable Development Goal (SDG) investing, the differences among these terms amount to shades of gray. The reality is, it kind of doesn't matter what you call it, as long as the definitions and measurements are clearly articulated, so investors can make an informed decision for themselves. Disagreeing over terminology can often be a convenient excuse for inaction.
It is now estimated that a third of the world’s managed assets — about $30 trillion — are in ESG investments, and growing. According to the Financial Times, in 2019, ESG-focused equity funds took in $70 billion in assets, while traditional equity funds recorded $200 billion in outflows. Some big financial firms — after years of considering ESG as lesser investment opportunities — are going all in. Data and measurement questions remain. What isn’t debatable, however, is the need for greater communication and understanding on the topic.
Andy Revkin, Director of Columbia’s Earth Institute Initiative on Communication & Sustainability, noted in a Twitter exchange the need to develop — in parallel to the climate science community’s effort to make their findings more digestible with the #SkypeaScientist initiative — the #SkypeaCorporateESG professional initiative.
Everyone — from individual investors to big financial firms — needs support on communicating ESG. But the best part is, if everyone becomes a sustainable investor, we all win. Sustainability is a way of looking at the world beyond zero-sum, and there is money to be made in the transition.
As the mainstream investing world begins to wake up to the realities (and risks) of climate change, ESG investing has an important role to play. Increased communication and awareness is the first step. But as the world’s financial infrastructure (like most of its systems) are built around carbon emissions, systemic change is needed. That will come from better data, analysis, and performance metrics. ESG’s shortcomings can be improved on, but it will require leadership from both the private and public sectors, as well as demand from investors big and small.