Taylor Gray, Ph.D.
The world is a better place when companies are good corporate citizens. I remain focused on developing meaningful and actionable insights from empirical data in pursuit of a better world.
Interest in ESG is growing at an astonishing rate. I’ve been working in this space for 15 years now and never did I imagine I would see the acronym used in popular commentary beyond the ears of specialist financial interests. ESG has gone mainstream--and truly mainstream, not just 'financial' mainstream--in a much broader manner than early practitioners and proponents could have ever hoped for.
But in this process, something has been lost in translation.
ESG is a universe of information that can serve as a foundation for a broader and more insightful Business & Society relationship...but how it is used is more important than the fact that it is used.
ESG is Data, Not Insight
ESG (as we discussed here and here) is a universe of information concerning a company’s environmental, social, and governance performance (the E, the S, and the G of ESG). It is data, both qualitative and quantitative, relating how a company’s culture, structure, and operations impact and are impacted by environmental, social, and governance issues of consequence.
But ESG is only data. It is not a framework, a value system, or a strategic roadmap. It is neutral in outlook and values. ESG data provides a clearer and more complete snapshot of how a company is operating and performing, and especially so when integrated with traditional financial reporting and analytics, but it is not a judgement of such operations and performance. It is data to support insights and opinions, but it is not insight nor opinion.
To say that ESG is data but not insight is not a criticism but rather a call to remember its fundamental importance...and limitations. ESG is a universe of information capable of serving as a foundation of a deeper Business & Society relationship and understanding, yet its potential is only realized when applied.
There is no such thing as an 'ESG company', rather all companies are ESG companies.
With the astounding growth in interest in ESG we are seeing this acronym attached to just about every aspect of corporate development, and increasingly to both marketing campaigns and stakeholder criticisms. Most commonly, ESG is being equated to sustainability (or lack thereof)--it is the new shade of green being mobilized for, and by, a new wave of consumer, investor, and stakeholder interests. This is excellent news for the popularity of ESG, but it is a dangerous path for the credibility of ESG.
We are now seeing companies being described as ‘an ESG company’ or a ‘company with good ESG’. We are seeing corporate annual reports blurring the lines between CSR initiatives and ESG data. We are seeing mutual funds and ETFs adding the acronym to any fund they want to market to retail investors interested in sustainability, impact investing, or social responsibility. In all these things, ESG is the new placeholder for sustainability--the new marker in the battle of good vs. bad, of a new ‘caring’ economy vs. a ‘traditional profit-maximizing-world-ending’ selfishness.
But ESG is none of these things. There is no such thing as an ESG company simply because all companies are ‘ESG companies’. Every company has environmental, social, and governance impacts and opportunities and hence data concerning these impacts and opportunities--that is, ESG data. A company may choose to disregard its ESG profile but this does not prevent the profile from existing. ESG is data--measures of real developments and interactions which exist whether someone cares about them or not.
To agree that a company or a fund is a ‘good' ESG company or fund is not to agree with specific ESG data but rather with someone’s specific interpretation of ESG data. So ask yourself, who is this someone?
There is nothing inherent in ESG to determine what is ‘good’ or ‘bad’. If ESG is being used to identify sustainable vs. unsustainable companies then it is being used as an input into someone’s own framework or definition of what sustainable means. ESG does not define sustainability but it can be used to measure a company’s progress toward meeting someone’s definition of sustainability.
This is critically important to remember--to agree that a company or a fund is a ‘good' ESG company or fund is not to agree with specific ESG data but rather with someone’s specific interpretation of ESG data. So ask yourself, who is this someone?
As an example, I can use ESG to help me consider investments in Unilever and ExxonMobil. I would establish my own framework for what I consider to be risks and opportunities and--and this is very important--over what specific timeline. I would then turn to ESG data to quantify these risks and opportunities and make a judgment as to whether Unilever or ExxonMobil, or both, met my investment threshold.
I can see that Unilever is actively managing its ESG-related impacts and perceived responsibilities and so likely to exact some form of opportunity within consumer markets increasingly supportive of such developments. In contrast, I can see that ExxonMobil is not; but I can also see that the risk exposure indicated within ExxonMobil’s ESG profile is not likely to materialize in any significant manner until at-least the medium term (3+ years) and certainly far after I intend to close my investment position in this company.
Within this investment framework, both Unilever and ExxonMobil can be ‘good ESG companies’. If I were an asset manager, I could place both these companies in an ETF to sell to retail investors and quite rightfully market it as an ESG-managed fund--and this would not be deceptive as I am actively and fully considering ESG data to determine which companies to include in the ETF.
And this is not a far-fetched example, rather it follows the path experienced by BlackRock in April, 2021. BlackRock launched the new U.S. Carbon Transition Readiness ETF which pulled in approximately $1.25 billion USD on opening day--a record across all ETF classes. This feat launched a wave of celebratory commentary across social media: this was proof that ESG was tipping the balance in capital markets, that the future of finance could be sustainable. But the celebrations were short lived.
Knowing the fund was built with consideration of ESG data, and given the fund's name, many passionate observers imaginatively anticipated the fund to be investing in a host of innovative climate-tech, renewable energy, geo-engineering, and 'transitional' companies. But it didn't take long to see that the fund's top 10 holdings mirrored those of most any regular large-cap tech ETF with holdings in Microsoft, Alphabet, Facebook, and Amazon. Really piling it on, the fund is also holding positions in ExxonMobil, Chevron, and ConocoPhillips, among other oil & gas companies.
The issue is not that the U.S. Carbon Transition Readiness ETF lied or otherwise misled investors. The fund is constructed and actively managed with ESG data integrated to financial data. The issue is that to so many outside observers, ESG had been equated with a particular vision of sustainability--a vision which in no way was inherent to ESG itself. The ETF actively uses ESG data--and in this it's record-setting success is a ringing endorsement of ESG--but most critical observers failed to remember that ESG is data...not sustainability.
ESG is Powerful...When Applied
Again, this is not a criticism of ESG but rather of how ESG is increasingly being used as short-hand for sustainability. ESG is remarkably powerful data, but it is only data. The power that comes from it is entirely dependent upon how it is used--upon how the framework that employs it is developed and who is actually developing it. ESG can be used to quantify sustainability, but not in and of itself. ESG is only sustainability when it is used within a framework that defines sustainability and mobilizes ESG data in relation to this definition.
ESG is a universe of information that can serve as a foundation for a broader and more insightful Business & Society relationship...but how it is used is more important than the fact that it is used. It is data, it is not in itself sustainability, impact, ‘caring’, or responsibility. To suggest otherwise is to expect something of it that it was never designed nor developed to accomplish, and this risks undermining its credibility.
ESG can enrich how we understand the world and our interactions therein, but it can also fuel the next era of greenwashing. As a proponent of this data, I recommend we embrace ESG, that we mobilize ESG, that we build from ESG...but that we do so responsibly.
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