Allison Kade has been upset about climate change ever since she was 6 years old, watching her favorite cartoon, “Captain Planet and the Planeteers.” Now, as a 35-year-old adult, she feels she can do something about climate change with her financial choices.
Kade considers herself a “conscious” investor. She uses a strategy known as ESG investing, which prioritizes “socially responsible companies” that focus on environment, social and governance issues.
“This feels like the adult manifestation of my childhood passion,” she says. “I can do something systematically that goes beyond the standard consumer fare, like changing out my light bulbs or some other pat advice.”
Kade is among the millions of Generation X and millennial investors who have contributed to the rise of ESG investing. These investments try to improve society and hold businesses to high standards of behavior, and they have become an influential financial force around the world.
Socially responsible investments are expected to reach $50 trillion by 2025, up from $30.7 trillion in 2018 and $22.8 trillion in 2016, according to data from the Global Sustainable Investment Association.
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Socially responsible investing is particularly popular with millennials concerned about climate change and how companies treat their workers. And the investment practice gained increased focus during the coronavirus pandemic as the global health crisis led many to make more deliberate decisions based on how their choices influence the economy and society at large.
“COVID has made everyone super-focused on how everything in the world is interconnected,” says R. Paul Herman, CEO of Human Impact & Profit Investor, or HIP Investor, which measures the performance of ESG investments. “It has gotten people asking, ‘What problems are we creating in the world? How do we address the root causes? How, as a society and an economy, do we become more resilient?’”
What is ESG investing?
The concept of ESG investing was developed early in this century by United Nations officials who worked with the finance industry.
They believed ESG factors in financial analysis could be in sync with investors’ fiduciary responsibilities. Their view was that ESG data would help protect investments by avoiding material financial risks from climate change, labor disputes, human rights concerns in a company’s supply chains and poor corporate governance and related litigation.
Over the decades, ESG investing has grown into a trillion-dollar enterprise that has had real-world impact on the economy, society, and the specific issues its investors care about.
Activist investors, for example, have gotten seats on Exxon’s board, and forced other companies to adopt sustainability goals and climate pledges and to add gender and racial diversity to their leadership. Some sustainable investing has pressured companies to use less plastic or perform civil rights audits.
“The growth of sustainable and ESG investing is being driven by more people realizing that it is the right thing to do and more people realizing that it is the smart thing to do,” says Zach Stein, chief investment officer of Carbon Collective, which provides sustainable investment portfolios for individuals and businesses’ 401(k) plans.
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What are the disadvantages of ESG?
Critics, however, say it is hard to clearly define what a socially responsible company is, and its potential to change the economy and capitalism for good is exaggerated. They complain that the ESG label is put on everything from investments in renewable energy stocks to more questionable investments in China, where ESG funds are quickly expanding.
Indeed, even Paul Clements-Hunt, who coined the term “ESG” at the start of the century, says the finance industry has called the practice “a whirligig, a frenzy, a marketing mania.”
Others who question a focus on socially responsible investing say a company’s main purpose is to make money for shareholders, and profit-making is ultimately what helps society.
One prominent critic of late is Florida’s Republican Gov. Ron DeSantis, who has built a national reputation and platform for a potential presidential run taking on “woke culture.” A state board chaired by DeSantis has banned investment fund managers from considering “social, political, or ideological interests” when making decisions for Florida’s retirement system.
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Texas and West Virginia are taking a similar approach, seeking to block investors from state business if they claim to boycott certain products or sectors. For example, Texas has banned state and local government agencies from doing business with financial firms that are boycotting the gun and fossil fuel industries. West Virginia is focused on financial firms that oppose coal.
And about 15 other states are considering similar steps.
“In 2022 the woke left is poised to conquer corporate America and has set in motion a strategy to enforce their radical environmental and social agenda on publicly traded corporations,” former Vice President Mike Pence wrote in a Wall Street Journal op-ed last year titled “Republicans Can Stop ESG Political Bias.”
Is ESG investing profitable?
But beyond the political questions surrounding ESG, some analysts say this investment strategy is breaking down.
“The space has collapsed slightly because these age groups don’t have the financial means to invest at a large scale,” says Larissa Greer, who helped design an ESG tool. “The desire has been there, but not the money.”
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Still, major Wall Street firms including BlackRock, the world’s largest asset manager, have centered this field of investment.
The firm has taken a lead in weighing in on government efforts to regulate ESG, working with the Securities and Exchange Commission on oversight. And BlackRock’s significant investment in ESG has helped push companies to comply with international agreements like the Paris Agreement that pushes for fossil fuels to be phased out. The firm has said that transitioning to clean energy is a profitable investment, not just a good thing to do.
But the firm has come under scrutiny from a group of state attorneys general over what has been seen as an aggressive push for ESG investing.
Ultimately, ESG investing does not appear to hurt the financial performance of companies or investors.
Tensie Whelan, director of New York University’s Stern Center for Sustainable Business, found that corporate sustainability initiatives often seem to fuel better financial performance based on his study of more than 1,000 research papers published between 2015 and 2020. The study also found that often ESG investment strategies delivered similar or better financial results than traditional investing approaches.
Several ESG large-cap equity funds did better last year than non-ESG funds. And when they did lose money, as part of a broader market selloff, their losses were smaller than their traditional counterparts. ESG funds were down globally 11.7% as of June 10, 2022 compared with a 14.8% drop in the MSCI World Index.
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The future of ESG
Yet even supporters of ESG investing say improvements can be made to better track the effect of these practices.
There is great variation in ESG disclosures by companies, and rating agencies that assess ESG data use proprietary practices, so investors don’t always know how those agencies came to their conclusions.
Despite the challenges, Greer believes ESG investing could be a major force for change. “The question is whether or not we can inspire people with purchasing power to choose investments that actively help our planet adapt to the future,” she says. “There is a larger divestment movement in fossil fuel. That gives me hope.”
In the end, the popularity of conscious investing may come down to a company’s financial appeal, not necessarily its good works, Stein of Carbon Collective says.
“Blockbuster vs. Netflix. Nokia vs. Apple. Fossil fuels vs. climate solutions,’’ he says. “Which would you rather have in your retirement savings? We believe it’s important for investors to think about the long-term staying power of the companies they are investing in.”