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From a look at the headlines, it would be easy to conclude that ESG practices—short for environmental, social, and governance—are on the way out. Political backlash from right-wing Republicans in the U.S. has left many big financial institutions reluctant to talk about their ESG policies. Funds focused on clean energy underperformed the broader stock market. And, for the first time last quarter, investors around the globe pulled out more from ESG funds than they put in, according to new data from Morningstar.
But give ESG a closer examination and the picture looks much more complicated. For one, some sustainable funds performed better than the stock market at large last year. And, notably, ESG investing continues to grow in some markets, including in Europe. Soon, the growing focus in the U.S. and elsewhere from governments seeking to create a regulatory framework is likely to quell some concerns about the category—and create new opportunities. Many businesses and investors have come to equate support for ESG with significant financial risk, but it’s clear there are big risks, too, in ignoring ESG principles.
To consider the current state of ESG, it’s helpful to look at the numbers. Globally, investors on net withdrew $2.5 billion from sustainable funds last quarter, according to Morningstar’s analysis. Over the course of 2023 $63 billion flowed into such funds, down from $161 billion the year before. (These numbers are large, but are less so in the scheme of the $3 trillion in the sustainable mutual and exchange traded funds assessed by Morningstar.)
The numbers varied widely from place to place. The U.S. saw a dramatic reduction in new money flowing into ESG in the fourth quarter; Europe continued to see gains. This might seem like a rather obvious result of the different political contexts of the two places—and, of course, that is an important part of the picture. The political right in the U.S. has demonized ESG to the point where it has come up in the presidential campaign and some states have gone so far as to restrict firms that engage in the practice from doing some business within the jurisdiction. By contrast, climate change, a key concern of ESG metrics, has been front-of-mind in Europe for years and remains not just a voting issue but a factor for pension funds and institutional investors.
But there’s also something to be said about time. Simply put, Europe has been in the ESG game longer. Investors have had more time to acclimate themselves and regulators are further along in the process of creating rules of the road. The U.S. is earlier in the policymaking journey, but it’s certainly happening with pending climate disclosure rules from both the SEC and the state of California. Implementing these measures should boost market confidence that ESG funds are actually sustainable, batting back the critique that they’re just greenwashing tools.
Still, all of this is predicated on investor demand—and investors follow returns. While it’s impossible to predict where the market is going, it seems fair to say that not all the challenges that hit ESG funds in recent years will be around forever. Supply chain issues, like the lack of solar manufacturing capacity in the U.S., for example, will be resolved eventually. And already some sustainable funds have experienced a rebound because they are so heavily focused on tech stocks.
All of this means that while ESG is here to stay in some form, it will face ups and downs, and it won’t be popular among all segments of the population. It may not even be called ESG anymore. But, for businesses, ignoring it amid the slowdown would be a big mistake.
FAQs
The researchers' findings indicate that when companies focus on nonmaterial ESG factors in their quarterly financial updates, investors interpret it as a negative sign, signaling potential issues like higher costs, inefficient resource use, and distracted management.
Why ESG is not important? ›
'The ratings and indices used by investors to identify ESG stocks are not designed to measure a company's positive impact on the Earth and society. Instead, they assess the potential impact the world has on a company's value and its shareholders. '
What are the challenges faced by an investor trying to invest in an ESG compliant company? ›
Lack of Data Granularity and Provenance: Investors face challenges due to the absence of detailed data and clear data sources, hindering their ability to assess ESG risk and performance accurately.
Can companies be penalized for not complying with ESG? ›
Failing to comply with these regulations can result in fines, sanctions, lawsuits and loss of licenses. To avoid this risk, businesses should monitor and align their ESG practices with the relevant legal frameworks and standards in their markets.
Why are companies against ESG? ›
For some, the rise of ESG funds is a threat. They don't want to see the world use the leverage of finance and reporting to address shared challenges; it would reduce their power.
What is the controversy with ESG? ›
Critics argue fund managers are prioritizing political goals over generating returns. A number of states have enacted restrictions limiting how state pension funds can incorporate ESG factors into investments.
Do investors really care about ESG? ›
Retail investors do care a lot about the ESG-related activities of the firms they invest in, but only to the extent that they impact firm performance, independent of ESG performance.
Does ESG really matter and why? ›
Successful companies are implementing ESG strategies that increase financial, societal, and environmental impact as well as ensure long-term competitiveness.
What investment companies do not use ESG? ›
Strive Asset Management and Inspire Investing offer the largest anti-ESG funds:
- Strive U.S. Energy ETF (DRLL): $369.2 million.
- Inspire 100 ETF (BIBL): $294.5 million.
- Strive 500 ETF (STRV): $266 million.
- Inspire Corporate Bond ETF (IBD): $256 million.
- Inspire International ETF (WWJD): $193 million.
Most often, the focus is on climate change. For example, ESG criteria would invest in green energy industries over fossil fuels—even though investments in oil and gas may perform better. The consequences are that investors accounts suffer, and resources and capital are directed away from the oil and gas industry.
Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.
What is wrong with ESG funds? ›
Critics see that as a sign that ESG is primarily a marketing resource for companies, rather than a concrete indicator of a company's sustainability. ESG funds are often more expensive than conventional products.
Does ESG violate fiduciary duty? ›
It places corporate directors and fund managers in the precarious position where the utilization of ESG and ESG investing is a breach of fiduciary duty, leaving them liable to civil action.
Can embracing ESG be bad for business? ›
The investor imperative
Shareholders and other investors also expect to see organizations making formal pledges to ESG standards before they commit funds. In short, conforming to ESG principles is clearly not just a box-ticking exercise: it could mean losing out on business, or funding, or both.
What are the risks of not reporting ESG? ›
Failing to comply with these regulations can result in hefty fines, legal battles, and reputational harm. An ESG and sustainability management system ensures companies stay ahead of evolving compliance requirements, reducing the risk of non-compliance and associated penalties.
What are the pros and cons of ESG? ›
Pros and cons of ESG investing
| Pros | Cons |
|---|
| Can help investors diversify their portfolio | ESG funds may carry higher than average expense ratios |
| May reduce portfolio risk | ESG investing is still a fairly new concept and there isn't a ton of reporting on performance |
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ESG refers to the environmental, social, and governance aspects of a company's operations that can affect its performance and value in the market. By considering these factors, businesses can better manage risks, unlock opportunities, and drive positive change within society.
What are the drawbacks of ESG ratings? ›
Main Problems with Data Used by ESG Rating Agencies
- Lack of quality data is traditionally identified as the main barrier to the objectivity of ESG ratings. ...
- Data is self-reported.
- Data is often obtained from third parties.
- Data is unaudited.
- Setting up Policies is Different from Having Measurable Impact.
ESG framework helps identify, organise, analyse, prioritise and accordingly guide decisions on various business risks. These risks, if left unaddressed can prove costly to the functioning and sustenance of businesses.
