ESG: A Maturing Market

With the increasing acceptance of ESG investing as a mainstream investment theme, investors are no longer short of ESG funds to choose from. As investor choice has grown, the spotlight has gradually shifted from seeking to increase the availability of such funds to a greater scrutiny of their ESG credentials.

‘Environmental, social and governance’: the label covers a huge amount of ground. It is no surprise then that there are considerable differences in its interpretation and its application to any given investment. McDonalds, for example, has made huge efforts in beef sustainability and is a leader in recycling. Nonetheless it remains a significant contributor to environmental problems and obesity. One man’s meat is another man’s poison.

Even putting aside individual (or institutional) preferences, the relativist approach taken by some ESG funds means that a company needn’t be ‘good’ per se to make the grade; it simply needs to be better than its sectoral competitors. This has led to the inclusion of oil majors, tobacco companies and defence contractors within a number of ESG-labelled funds.

It is clear that the label given to a particular ESG fund should be treated with caution. The due diligence required to validate the ESG credentials of a fund is typically beyond most investors, whether in terms of resource or inclination.

One report* claimed that 74% of respondents “would be shocked if a fund claiming to be ‘ethical’ turned out to be investing in companies that negatively impact people and the environment.” But given the flexibility of interpretation in this area, it would be surprising if there were not significant gaps between investor expectations and reality.

Inevitably there are concerns that this gap between expectation and reality (in some cases, a brazen attempt to ‘greenwash’) could presage a set-back for the industry. A more likely outcome is that increased awareness and publicity will drive gradual qualitative improvements.

Overall, this development can be viewed as a positive - the importance of ESG investing is by and large no longer in question; instead the debate is focusing on the quality of those investments. It will be interesting to see where this leads. More widespread adoption of a small number of tried and trusted methodologies? Standardisation driven by regulatory oversight? An increased role for trusted and independent third party intermediaries to assess ESG credentials?

Ben Ferry

*Castlefield Consumer Survey, October 2015.