BACK TO THE BOUTIQUE INVESTOR BLOG What Critics Get Wrong—and Right—About ESG Investing Leah Turino, CFP HEAD OF ESG INTEGRATION | BOSTON COMMON ASSET MANAGEMENT Sustainable investing is under a microscope. Everywhere, it seems, investment managers are talking about their approach to environmental, social and governance (ESG) investing. The number of investors pursuing ESG continues to grow, with ESG assets under management expected1 to comprise a third of all global assets—$50 trillion—in less than three years’ time. And even as established, traditional asset managers scramble to roll out their ESG offerings to attract clients, there are some, including individuals inside these very same firms, who are critical of the entire approach. The full investment value chain—from companies resistant to climate and social disclosure, to research providers who utilize “black box” models—must be more transparent and better aligned… ESG investing has long had skeptics who have doubted whether it’s possible to invest for both financial returns and social impact. Our firm has been hearing this brand of criticism since we were founded in 2003. The argument then was that ESG investing would, by nature, underperform financially, that nonfinancial considerations would compromise profits. But with the path to financial returns increasingly run through social change, thus leading ESG performance to rival benchmark indices, skeptics now argue that ESG isn’t effective at achieving environmental or social change. Increasingly, we see critics charge that ESG investors are “avoiding hard choices” and falling for spin from companies making “disingenuous promises” that don’t move the needle on sustainability issues like climate change. Certainly, ESG investors aren’t above criticism. As Preventable Surprises2 found, despite promises of transparency and action, less than a third of the Top 50 asset managers provide public information on their own trade association affiliations—and only 1 in 5 support disclosure of climate lobbying and political finance. And it’s not just large asset managers. The full investment value chain—from companies resistant to climate and social disclosure, to research providers who utilize “black box” models—must be more transparent and better aligned when it comes to ESG as we saw last fall: when a $2 trillion investor coalition had to urge proxy voting giant ISS to reconsider how it approaches climate risk3 in its voting recommendations (an investor letter our firm signed onto). As ESG investors, we welcome this scrutiny. Scrutiny must be at the heart of ESG investing if we’re going to challenge long-held assumptions. After all, there should be a demonstrable positive impact in addition to financial returns. That is why efforts like the EU Taxonomy4 (the European Union’s classification system for sustainable activities), the Sustainable Finance Disclosure Regulation5 (“SFDR”) (a set of EU rules that make it easier for investors to understand and compare the sustainability profile of investment funds), and proposed rules6 at the U.S. Securities and Exchange Commission to enhance ESG disclosure are so important. But the goal of ESG investing isn’t to solve climate change or end human rights abuses by itself. Rather, it’s about reorienting our financial system so that capital flows from companies externalizing the environmental and social costs of their product offerings to those that are finding ways to profit from taking action. Whether it’s PNC innovating sustainably for a competitive edge by reducing its loan footprint for mountaintop-removal mining, or Verizon’s CEO Hans Vestberg following through7 during the pandemic on his commitment to create a better work culture and more career choice for employees, or Adidas selling tens of millions of sneakers manufactured from recycled plastic recovered from the ocean, these companies exist, and more investors appreciate them. In this era of Stakeholder Capitalism, investors see value in companies prioritizing and managing ESG, as well as assessing and managing the real-world impacts of the products and services that they offer. That’s not to say all ESG managers are created equal. Considering the increasing interest in exploring this rapidly growing space, it’s no surprise that some products and managers aren’t up to the task. Red flags include misaligned proxy votes, such as voting against environmental and social shareholder proposals and voting overwhelmingly in support of excessive CEO pay. And there are other hints as well: A firm might offer a single thematic fund or product instead of integrating ESG across all assets under management, or it might “integrate” its investment processes by relying exclusively on third-party ESG data. Another red flag: if a firm says one thing in public on issues like racial equity or climate but its own policies, governance, investing and engagement practices say something else. Authentic ESG managers understand that the planet, profits, and policy are inseparable and that capital and disclosure play a role in driving policy and impact. By contrast, the firms “doing ESG right” are making firm-level commitments, backing up what they say with what they do. They’re integrating research with the investment process. They’re voting their proxies and partnering with diverse stakeholders to uncover the potential of advocacy. They’re signing on to existing coalitions and reporting standards, as well as embedding ESG practices throughout their organizations. And increasingly they are stepping up—and out—on policy engagement. While ESG critics argue that profits will always be a higher priority than the planet—and that investing is no substitute for policy—authentic ESG managers understand that the planet, profits, and policy are inseparable and that capital and disclosure play a role in driving policy and impact. Indeed, the action we are seeing from regulators in Europe and the U.S. would not have happened without increasing pressure for climate disclosure and human rights due diligence by companies and investors. All of which is to say: While there may always be some skeptics, ESG investing is here to stay. Investors expect a financial return, but they also want a better understanding of what they’re investing in and to align their investments to their values. Increasingly, ESG investors are making that happen. 1 Bloomberg Intelligence ESG 2021 Midyear Outlook. London and New York, July 20, 2021 – Environmental, Social and Governance (ESG) assets are on track to exceed $50 trillion by 2025, representing more than a third of the projected $140.5 trillion in total global assets under management, according to Bloomberg Intelligence’s (BI) latest ESG 2021 Midyear Outlook report. 2 https://preventablesurprises.com/corporate-political-capture/top-50-asset-managers-have-yet-to-match-rhetoric-with-action-to-address-negative-lobbying-corporate-policy-capture-report/ 3 https://static1.squarespace.com/static/5d4df99c531b6d0001b48264/t/61a65a0ececad912609ce545/1638291984575/Investors+challenge+ISS+over+%25E2%2580%2598inadequate%25E2%2580%2599+response+to+climate+in+planned+voting+advice+for+2022.pdf 4 https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/eu-taxonomy-sustainable-activities_en 5 https://www.robeco.com/en/key-strengths/sustainable-investing/glossary/eu-sustainable-finance-disclosure-regulation.html 6 https://news.bloomberglaw.com/securities-law/sec-wants-to-shed-light-on-funds-esg-claims-with-new-disclosure 7 https://www.forbes.com/sites/stevenbertoni/2021/02/02/ceo-spotlight-verizon-boss-on-leading-through-covid-19-handling-historic-digital-traffic-and-why-5g-will-change-everything/?sh=1dbe5e403db7 Past performance is not a guarantee of future results. Investing involves risk including possible loss of principal. This does not constitute investment advice or an investment recommendation. This represents the views and opinions of Boston Common Asset Management. It does not constitute investment advice or an offer or solicitation to purchase or sell any security and is subject to change at any time due to changes in market or economic conditions. The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. Any securities discussed herein do not represent the entire portfolio and in aggregate may represent only a small percentage of a portfolio’s holdings, or, may not be held in an account’s portfolio at all. It should not be assumed that any of the securities transactions discussed were or will prove to be profitable, or that the investment recommendations we make in the future will be profitable or will equal the investment performance of any security discussed herein. Applying ESG investment criteria to investments may result in the selection or exclusion of securities of certain issuers for reasons other than performance, and may underperform investments that do not utilize an ESG investment strategy. The application of an ESG strategy may affect an investment’s exposure to certain companies, sectors, regions, countries or types of investments, which could negatively impact performance depending on whether such investments are in or out of favor. Applying ESG criteria to investment decisions is qualitative and subjective by nature, and there is no guarantee that the criteria utilized or any judgment exercised by an investment manager will reflect the beliefs or values of any particular investor.