As explored in my previous Spotlight article on ESG investing<\/a>, the basic idea is simple. \u00a0Rather than simply considering financial returns, ESG investors also consider the impact of their choices in terms of the environment, society and corporate governance. \u00a0In these three key areas, they aim to avoid contributing to damaging outcomes, and ultimately become a force for good.<\/p>\n The Bloomberg Intelligence survey findings align with other similar research. \u00a0An asset and wealth management (AWM) report[2]<\/a> in 2022 from PwC highlighted a similar surge in demand for ESG investments, stating that ESG-related assets under management were set to grow globally at a much faster pace than the AWM market as a whole\u201d\u2013 to US$ 33.9 trillion by 2026, from US$ 18.4 trillion in 2021.<\/p>\n It seems clear that ESG investment is a force of growing significance in the global economy. \u00a0But what does it mean in practice?<\/p>\n Considering the impact of investments beyond narrow financial criteria isn\u2019t a new idea. \u00a0ESG\u2019s roots go back at least as far as the 1960s, when amid prominent political protests and campaigns, some investors sought to make more socially responsible decisions. \u00a0This included those who avoided investments in certain industries (such as tobacco production) or associated with particular governments (such as South Africa\u2019s apartheid regime).<\/p>\n There were, of course, much earlier attempts to ensure that investments were ethically or religiously appropriate. \u00a0But modern ESG principles first began to be formalized in the early 21st<\/sup> Century, with the support of the United Nations (UN). \u00a0A 2005 report from the UN Global Compact argued that in an increasingly complex and interconnected world, new challenges were emerging around \u201cactively managing risks and opportunities related to emerging environmental and social trends, in combination with rising public expectations for better accountability and corporate governance\u201d [3]<\/a>.<\/p>\n The document, developed in consultation with 18 financial institutions from nine countries, highlighted the importance of these issues both for companies and investment portfolios, and made recommendations for the financial industry to better integrate ESG principles. \u00a0These included a call for investors to \u201cexplicitly request and reward research that includes environmental, social and governance aspects\u201d, and to reward companies that were managed well.<\/p>\n Since then, ESG investment has grown substantially, and now forms a significant share of the overall market. \u00a0A report from the Global Sustainable Investment Alliance found that in 2022, US$ 30.3 trillion was invested globally in assets that follow ESG principles. \u00a0Across Europe, Canada, Australia and New Zealand, and Japan, sustainable investing assets totaled US$ 21.9 billion, representing 38% of total managed assets[4]<\/a>.<\/p>\n These investment trends support greater consideration of ESG principles across the corporate world as a whole. \u00a0A 2022 review from McKinsey[5]<\/a> confirmed that organizations across different industries, geographies, and company sizes have been allocating more resources toward improving ESG. \u00a0More than 90% of companies in the Standard & Poor\u2019s 500 Index now publish\u00a0ESG reports\u00a0in some form, it pointed out, and about 70% of those in the Russell 1000 Index. \u00a0These figures are likely to have risen further still in the period since the report was published.<\/p>\n Looking at the individual strands of ESG practices, McKinsey says the environmental element may include consideration of climate change, air pollution and waste management. \u00a0The social dimension, meanwhile, could address factors such as labor practices or health and safety. \u00a0And the governance strand could incorporate themes such as business ethics and supply chain management, as well as organizational decision-making structures.<\/p>\n So, what is really behind the growing focus on ESG? \u00a0JP Morgan Asset Management highlights government policy as an important driver[6]<\/a> \u2013 pointing, for example, to the impact of the 2015 Paris Agreement and its objective to limit global warming to within 2o<\/sup>C of pre-industrial levels, preferably to 1.5o<\/sup>C.\u00a0 In line with this, more than 70 countries have now set ambitious targets for reducing emissions. \u00a0Meeting these goals will require a range of policy measures such as new funding initiatives, regulations and taxes. \u00a0Governments are increasingly introducing mandatory ESG reporting requirements and corporate strategies are responding to the rapidly evolving policy context.<\/p>\n According to JP Morgan\u2019s analysis, changing public attitudes are also impacting corporate actions. \u00a0The trend for consumers \u201cvoting with their wallets\u201d, in line with the values they want to see, creates a bottom-up incentive for companies to take action. \u00a0At the same time, increased public scrutiny of governments in relation to ESG puts pressure on them to apply top-down measures. \u00a0This situation creates compelling opportunities for investors to back companies that have responded to ESG concerns, say analysts.<\/p>\n This includes social and governance considerations as well as environmental sustainability. \u00a0Social movements such have increased the prominence of social justice concerns, as have some ongoing global economic trends. \u00a0JP Morgan argues that many years of low wage growth, plus the COVID-19 pandemic, have focused attention on workforce issues. \u00a0And as specialist ESG investment firm ADEC Innovations points out, as supply chains become more complex, there is greater awareness of the social, labor, and human rights risks these create for business[7]<\/a>. \u00a0One feature of this new landscape is an increasing corporate focus on diversity and inclusion, as evidenced in the significant rise in the use of these terms in quarterly earnings calls between large companies, investors and analysts.<\/p>\n ESG issues are increasingly becoming a legislative and regulatory matter, too. Modern slavery laws in the UK, US, Canada and Australia among others, for example, require businesses over a certain size to report on what they are doing to ensure that modern slavery and human trafficking is not taking place in either their business or, crucially, their supply chains, which sits firmly under the \u2018S\u2019 for social, in ESG.<\/p>\n It is not only a \u2018desire to do good<\/em>\u2019 that is driving ESG activity. \u00a0There are strong financial reasons, too.\u00a0 There is plenty of evidence that ESG investments perform at least as well as others, if not better. \u00a0A study in 2023 by Kroll[8]<\/a>, which analyzed data from more than 13,000 companies, found that those with stronger ESG credentials also delivered better financial returns. \u00a0Firms categorized as \u201cleaders\u201d in ESG saw annual returns of 12.9%, compared to 8.6% for \u201claggards\u201d \u2013 representing a performance premium of around 50%. \u00a0This follows a study in 2021, which examined more than 1,000 research papers published over the previous five years. \u00a0Researchers found that 59% of the relevant studies showed similar or better performance from ESG investments compared to standard approaches, with only 14% finding negative results.<\/p>\n So, consideration of ESG can have a positive impact on companies\u2019 profits, reputation and resilience, as well as being good for the planet and society.<\/p>\n In this light, rather than seeing ESG as a distraction from good business, the increasing consensus has been \u2013 and must continue to be \u2013 towards integrating it into mainstream thinking and practice. \u00a0This approach was endorsed in a January 2020 letter to chief executives from Larry Fink, head of the US investment firm Blackrock. \u00a0Focusing particularly on environmental sustainability, Fink argued that the increasing significance of climate change risks meant \u201cwe are on the edge of a fundamental reshaping of finance\u201d[9]<\/a>.<\/p>\n In his assertion that \u201cclimate risk is investment risk\u201d, Fink explicitly aligned ESG concerns with best business practice. \u00a0He reiterated his view that \u201cpurpose is the engine of long-term profitability\u201d and warned that Blackrock would be increasingly disinclined to back the management of companies that were not making sufficient progress on sustainability.<\/p>\n Yet the more ESG enters the mainstream, the more scrutiny it faces. \u00a0Some experts suggest the momentum behind the concept may have slowed and that skepticism is growing. \u00a0Richard Stone, chief executive of the UK-based Association of Investment Companies (AIC), for example, said the organization\u2019s research \u201csuggests that 2021 may have been a high point for enthusiasm about ESG investing\u201d, with their research suggesting the proportion of private investors considering ESG factors has fallen over the past two years[10]<\/a>.<\/p>\n In 2021, almost two thirds (65%) of those surveyed said they gave thought to ESG factors when investing. \u00a0The next year, this had fallen to 60%, and in 2023, it dropped further to 53%.<\/p>\n Among the 47% who did not think about ESG factors, the top reason given was prioritizing performance over ESG issues, with \u201cnot being convinced by ESG claims from asset managers\u201d coming close behind.<\/p>\n The survey also found concerns about \u2018greenwashing\u2019 \u2013 meaning exaggerated or misleading claims made about supposedly sustainable practices. \u00a0In the AIC survey, 63% of respondents said they were concerned about greenwashing. \u00a0The proportion of investors agreeing with the statement that \u201cI\u2019m not convinced by ESG claims from funds\u201d has grown \u2013 from below half (48%) in 2021 to almost two thirds (63%) in 2023.<\/p>\n Recent high-profile accusations of corporate greenwashing may well have helped bring this issue to the forefront of investors\u2019 minds. \u00a0In 2023, for example, the campaign group Global Witness filed a complaint against the oil giant Shell with the Securities and Exchange Commission in the US, claiming the company had misled investors. \u00a0Global Witness said that while Shell claimed to spend 12% of its annual expenditure on renewables and energy solutions, its analysis found that the company only allocated 1.5% of its overall spending towards solar and wind power generation.<\/p>\n In the UK, regulators have found a number of energy companies guilty of greenwashing. \u00a0Shell was one of three fossil fuel businesses whose campaigns were banned in June 2023 by the Advertising Standards Authority for misleading the public about their products\u2019 environmental benefits[11]<\/a>. \u00a0It isn\u2019t just oil and gas firms facing criticism. \u00a0The UK\u2019s Competition and Markets Authority (CMA) announced in December 2023 that it would be investigating Unilever \u2013 which makes a wide range of consumer goods \u2013 over concerns it was making misleading sustainability claims, as part of a wider investigation into greenwashing. \u00a0The CMA\u2019s chief executive Sarah Cardell said the watchdog was \u201cworried many are being misled by so-called \u2018green\u2019 products that aren\u2019t what they seem\u201d.<\/p>\n There are also concerns that some investment funds may have engaged in greenwashing-style practices. \u00a0In a recent blog for the Centre for Economic Policy Research (CEPR)[12]<\/a>, academics from France\u2019s EDEHC business school argued that there is evidence that \u201cfund managers may game regulatory disclosure to disguise themselves as sustainable, while including higher performing yet controversial assets in their portfolios\u201d.<\/p>\n The researchers point out that while sustainability ratings provided by industry analysts have increased transparency, they are calculated based on disclosures from funds which only have to be made a few times a year. \u00a0This leaves it open for unscrupulous managers to strategically purchase ESG stocks just before disclosure to increase their sustainability ratings, before shifting back to higher yielding yet less responsible assets when detection is unlikely.<\/p>\n Worryingly, the researchers found evidence to suggest this was indeed happening in some cases, by comparing the performance of ESG funds against major ESG stock indexes. \u00a0The analysis found that correlation between these drops significantly right after mandated disclosure, when there was also a sudden increase in correlation with the performance of high-emission stocks. \u00a0Based on these findings, the academics conclude that \u201csome funds engage in green window dressing\u201d.<\/p>\n The findings come amid ongoing confusion over how ESG funds are classified \u2013 an issue that has been particularly prominent in Europe.<\/p>\n In July 2022, the European Commission (EC) issued new guidance on sustainable investment funds, prompting hundreds of funds to have their sustainability status downgraded from the top-rated \u2018article nine\u2019 (where there must be an explicit sustainable investment objective) to the less stringent \u2018article eight\u2019 category. \u00a0According to data from Morningstar, in the fourth quarter of 2022 funds holding a total of US$ 193 billion were downgraded from article nine classification following the EC\u2019s intervention[13]<\/a>.\u00a0 In light of further clarification from the EC in April 2023, some 35 funds were upgraded back to article nine, but the numbers remain far below the previous mark.<\/p>\n Alongside this confusion, the concept of ESG itself has come under political attack, particularly in the US. \u00a0In Florida, laws were passed that ban the consideration of ESG factors in state and local government investment decisions, stating that these must be based solely on \u201cpecuniary factors\u201d[14]<\/a>. \u00a0This follows laws that limit the use of ESG in a number of other states, as the idea has become embroiled in cultural disputes. \u00a0Florida\u2019s governor Ron DeSantis has accused corporations of injecting \u201can ideological agenda through our economy rather than through the ballot box,\u201d and said the state\u2019s new laws would \u201creinforce that ESG considerations will not be tolerated here in Florida\u201d. \u00a0This followed similar criticism of ESG from Mike Pence, the former US vice president, who wrote that the concept \u201cempowers an unelected cabal of bureaucrats, regulators and activist investors\u201d to impose their own political values.[15]<\/a><\/p>\n Whatever one\u2019s own views, it is clear that ESG has become an increasingly politicized term \u2013 and that this has made some investors more wary of using it. \u00a0Blackrock\u2019s Larry Fink, for example, previously a vocal supporter of the ESG approach, announced he had stopped using the phrase, which he said had been \u201cweaponized\u201d. \u00a0Although he said his firm had not changed its stance on ESG issues and would continue to support goals such as decarbonization in the companies it invests in.<\/p>\n Given the various political and regulatory headwinds faced by ESG, it\u2019s hardly surprising that there are growing questions about the idea. \u00a0But in my opinion, the increasing criticism that ESG is facing is an inevitable reaction to it reaching maturity, and ultimately a positive sign.<\/p>\n If the concept is sound, after all, it should be able to withstand robust scrutiny. \u00a0That scrutiny will inevitably result in some less valid ESG claims being exposed and bring unfortunate cases of greenwashing to wider attention. \u00a0But I firmly believe it also means we can have greater faith in the investments and initiatives that hold up to the increased attention.<\/p>\n Greater transparency and rigor will be important to moving forward with ESG investment. \u00a0So, I find it encouraging that this year the International Auditing and Assurance Standards Board announced proposals to develop new global assurance standards for sustainability reporting[16]<\/a> \u2013 with supporters of this idea including Norway\u2019s sovereign wealth fund. \u00a0This move forms part of ongoing efforts around the world to tighten the regulation surrounding ESG investment[17]<\/a>. \u00a0While in the short term this may well cause some difficulties, it should ultimately lead to greater clarity and confidence.<\/p>\n We\u2019ve seen in recent years how ESG investment has sometimes been the subject of rather excessive claims, whether it is being portrayed as a positive or nefarious force. \u00a0But in my experience, successful investors can be identified by their ability to see the reality behind the rhetoric. \u00a0And anyone who examines the current situation honestly can see that the environmental, social and governance challenges that that global economy faces are very much real. \u00a0That\u2019s why ESG investment looks certain to form an integral part of our financial future. \u00a0It\u2019s down to us all to make sure that it does so with the greatest possible success.<\/p>\n [1]<\/a> https:\/\/www.esginvesting.co.uk\/2023\/11\/bloomberg-survey-shows-rising-esg-interest\/<\/a><\/p>\n [2]<\/a> https:\/\/www.pwc.com\/gx\/en\/news-room\/press-releases\/2022\/awm-revolution-2022-report.html<\/a><\/p>\n [3]<\/a> https:\/\/www.unepfi.org\/fileadmin\/events\/2004\/stocks\/who_cares_wins_global_compact_2004.pdf<\/a><\/p>\n [4]<\/a> https:\/\/www.gsi-alliance.org\/wp-content\/uploads\/2023\/12\/GSIA-Report-2022.pdf<\/a><\/p>\n [5]<\/a> https:\/\/www.mckinsey.com\/capabilities\/sustainability\/our-insights\/does-esg-really-matter-and-why#\/<\/a><\/p>\n [6]<\/a> https:\/\/am.jpmorgan.com\/gb\/en\/asset-management\/institutional\/investment-strategies\/sustainable-investing\/esg-investment-landscape\/<\/a><\/p>\n [7]<\/a> https:\/\/www.adecesg.com\/resources\/faq\/what-is-esg-investing\/<\/a><\/p>\n [8]<\/a> https:\/\/www.kroll.com\/en\/insights\/publications\/cost-of-capital\/esg-global-investor-returns-study<\/a><\/p>\n [9]<\/a> https:\/\/www.blackrock.com\/americas-offshore\/en\/larry-fink-ceo-letter<\/a><\/p>\n [10]<\/a> https:\/\/www.theaic.co.uk\/aic\/news\/press-releases\/esg-investing-declining-in-popularity-as-fears-of-greenwashing-grow<\/a><\/p>\n [11]<\/a> https:\/\/www.ft.com\/content\/fec9e504-7006-495a-964a-ba2ded4df5ad<\/a><\/p>\n [12]<\/a> https:\/\/cepr.org\/voxeu\/columns\/smoke-and-mirrors-look-inside-esg-fund-portfolios<\/a><\/p>\n [13]<\/a> https:\/\/www.reuters.com\/business\/sustainable-business\/more-eu-green-funds-re-badged-amid-regulatory-drive-morningstar-2023-01-26\/<\/a><\/p>\n [14]<\/a> https:\/\/www.hklaw.com\/en\/insights\/publications\/2023\/06\/new-florida-law-prohibits-use-of-esg-factors-in<\/a><\/p>\n [15]<\/a> https:\/\/www.wsj.com\/articles\/only-republicans-can-stop-the-esg-madness-woke-musk-consumer-demand-free-speech-corporate-america-11653574189<\/a><\/p>\n [16]<\/a> https:\/\/www.bloomberg.com\/news\/articles\/2023-08-02\/company-esg-claims-to-soon-face-audits-amid-greenwashing-fears<\/a><\/p>\n [17]<\/a> https:\/\/www.nortonrosefulbright.com\/en\/knowledge\/publications\/8c48a4f6\/financial-services-regulation-and-esg-regulation-around-the-world<\/a><\/p>\n","protected":false},"featured_media":116731,"template":"","tags":[],"acf":[],"yoast_head":"\nOrigins and growth of ESG<\/h2>\n
![\"Snapshot](\"https:\/\/media.alj.com\/app\/uploads\/2024\/05\/Snapshot-of-global-sustainable-investing-assets-2016-2022-USD-billions_v2.jpg\")
<\/p>\nReasons behind the change<\/h2>\n
![\"A](\"https:\/\/media.alj.com\/app\/uploads\/2024\/05\/Corporate-mentions-of-diversity-and-inclusion-in-earnings-calls_V2.jpg\")
<\/p>\nPushback<\/h2>\n
![\"A](\"https:\/\/media.alj.com\/app\/uploads\/2024\/05\/of-investors-who-find-ESG-factors-important.jpg\")
<\/p>\nGreen window dressing<\/h2>\n
![\"Line](\"https:\/\/media.alj.com\/app\/uploads\/2024\/05\/Responsible-stocks_V2.jpg\")
<\/p>\nPoliticization<\/h2>\n
Rhetoric and reality<\/h2>\n