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.
To say that ESG is booming is an understatement...and as someone active in this space throughout the past 15 years, that is a statement I never expected to make.
2021 has brought about record inflows to sustainable funds (also often titled as Green, Climate, Impact, and ESG funds) as well as a record number of such funds. Reporting from Q1 of 2021 now shows over USD $2 Trillion in assets under management in these funds.
Such growth is excellent news for the sector, but, unfortunately, also a catalyst for grifters, cons, and predatory fund providers. Along with all the new ESG and Sustainable funds come seemingly even more old and flailing funds simply being repackaged as ‘ESG’ or ‘Sustainable’.
Reports of fund greenwashing are getting so egregious and prevalent that the US Securities and Exchange Commission (SEC) has been pushed to launch the Climate and ESG Task Force to investigate misstatements, miscommunications, and misleading disclosures relating to investment advisers’ and funds’ ESG strategies.
That so much greenwashing has been able to seep into the sustainable fund world is not surprising. Interest in ESG has grown much faster than has the understanding of ESG, and now even the term ESG is being popularly used to represent topics and issues it has no business representing. Greenwashing can take hold in this space because everybody wants ESG but fewer people fully understand ESG.
If data sources, processes, and objectives are not aligned then there is a strong chance we are looking at greenwashing instead of meaningful ESG.
So, What is ESG?
There will certainly be differences of opinion when it comes to defining and acting on ESG, but here are a few points that could be taken into consideration when formulating an actionable understanding of the topic.
Most importantly, ESG is data. That’s it. It is not a promise of anything to come, it is simply data.
ESG is both qualitative and quantitative data reflecting measures of corporate performance on environmental, social, and governance issues which are deemed to be material to the operation of respective companies. It is a window into how companies are operating and of their impacts on a series of what have traditionally been called 'extra-financial' indicators. ESG is a new degree of transparency.
And it is important to remember that transparency creates opportunities, not outcomes. ESG is data which can be used to achieve a desired outcome but it is not a process toward that outcome in itself. ESG is not sustainability, nor low-carbon, impact, green, or any other synonym being used to communicate progress towards a re-balancing of benefits and consequences to people and the planet. ESG can be an instrumental component in such trajectories, but it is not inherently of these in and of itself.
Like in all things data, it is critical to peek behind the curtain...and once you do, you may discover that ESG is not what you thought it was...
As an example, imagine I want to make an investment in the energy sector. I see markets are shifting as consumers and voters are becoming increasingly concerned with issues of sustainability and so I want to take a position that will capitalize on this shift.
Position A: I rely on aggregated ESG data to filter out any and all energy sector companies that are involved with thermal coal or oil sands, those which do not have decreasing year-over-year carbon emission intensities, those which do not have a carbon neutrality policy, those which do not a sustainability committee of the board of which at least one independent director is part of, and so on. Of the companies that are left, I review financial data to make an optimal decision believing I have been able to identify a financially-promising and sustainably-oriented energy company to invest in.
Position B: I sense that this shift toward sustainability is going to make capital more ‘expensive’ for the so-called laggards of the industry, meaning I can take a larger position for my same amount of investment. When the next polar vortex hits in North America and Europe there will be a surge in demand and even these laggards will be called upon to help, sending their stock prices climbing. In this case, I rely on ESG data to find the companies that are remaining highly focused on hydrocarbon development with only little or no tangential investment into renewables/sustainability. Their traditional focus may seem a weakness in today’s landscape and serves to keep their stock price relatively lower, but it is exactly this traditional focus that will be rewarded in times of grid stress.
These positions are diametrically opposed. Position A is developed with concern for sustainability while Position B is developed with a complete disregard for sustainability...yet both positions are developed using ESG data! And in this sense, both are accurately in the universe of ESG.
Popular press and plenty of marketing campaigns have been purposefully, or inadvertently, shifting the narrative. Where we once spoke separately of Corporate Social Responsibility, Sustainability, and ESG we now only speak of ESG. It’s not that we have all lost interest in CSR and Sustainability, but rather that ESG has become shorthand for just about everything now.
This keeps the storyline simple, quick, and punchy--and let’s everyone speak of the ‘softer’ environmental and social aspects with trending industry jargon--but it is truly a disservice to ESG and sustainability. Even more so as an increasing number of retail investors are turning to ESG-branded products.
ESG can be used to inform a sustainability-oriented position, but it is not itself sustainability. ESG is data, and like all things data, to truly understand it you must consider:
- What data is being used? ESG is a complete universe of data and it is unlikely any analysis is ever using all of it. So exactly what data is being used? Where is it sourced from? What does it reference?
- How is the data being used? Data is but one input in a process, so what is the process at play? How the data is used is often more important in determining any outcomes or interpretations than is the type of data being used.
- To what end is the data being used? A meaningful data analysis process should be purposefully constructed with a clear objective in mind...So, what is the objective? Is the objective to identify sustainability, is it to optimize growth or value, is it to maximize profitability, or so on?
Answers to these questions should all line up. If data sources, processes, and objectives are not aligned then there is a strong chance we are looking at greenwashing instead of meaningful ESG.
I am a big proponent of ESG. I have been working in this space for a long time. I personally engage ESG to promote sustainability, but I certainly do not pretend that ESG on its own will lead to sustainability. It is an opportunity, but we must set the trajectory.
I encourage and support ever more development in the ESG field. There is so much that can be done with this new window into corporate performance, but there is also so much that devious actors can also do to take advantage of this growing movement. Like in all things data, it is critical to look behind the curtain...and once you do, you may discover that ESG is not what you thought it was...