End of the Road for ESG?

ESG is certainly a hot topic at the moment. The ESG conflict has been brewing for a while, but it seems that with a stronger presence on the right, politicisation and pressure surrounding the topic is coming to a boiling point. Although, as Republicans battle against ESG finance and ‘woke-ness’ in general, the dissension seems to be more political than anything else.

With all the noise, you might be wondering, ‘what does ESG stand for?’, or ‘what ESG stocks should I buy?’. While we can't offer any investment or financial advice, we can explore ESG’s meaning as well as what ESG finance looks like today and what the space holds moving forward. In this article we will explore what ESG is, what is happening in the ESG space and where it could be headed in the future.

What is ESG?

ESG stands for Environmental, Social, and Governance and is a set of criteria that investors use to assess a company's ethical and sustainability practices. In recent years, ESG has drawn an increasing amount of attention in the world of finance, as investors seek to align their investments with their values. Additionally, there has been some research to suggest that ESG conscious portfolios can produce better returns than those that do not consider Environmental, Social, and Governance factors. However, it being such early days for ESG, this has been dismissed by critics as largely anecdotal or selectively misleading.

ESG’s meaning in business contexts refers to the integration of environmental, social, and governance factors into a company's decision-making processes. Companies that prioritize ESG considerations are said to be ESG compliant. This can include practices such as reducing greenhouse gas emissions, promoting workplace diversity, using renewable energy, implementing transparent governance structures or something as simple as a recycling program. Equally, on the investment side, ESG financing refers to the practice buying stock in companies that meet certain ESG criteria. ESG investing has become increasingly popular in recent years, as investors seek to support companies that are making a positive impact on the world.

Socially responsible companies might prioritize employee well-being, such as offering fair wages or flexible work arrangements. Practices might also include transparent reporting or independent board oversight. In theory, these decisions create a more holistically successful and resilient business. Companies that treat employees in a fair manner have lower employee turnover. Companies that are environmentally sustainable will have more longevity as renewable energy becomes more commonplace. Companies that treat people with respect and dignity have stronger brands and success stories. However, the narrative surrounding whether this is the case or not can vary wildly depending on who you ask – I'm sure Trump would have a very interesting answer, having called ESG investing “radical-left garbage” earlier this year.

What's Happening in the ESG Space Right Now?

The US Senate recently voted to overturn a Labor Department rule that allows fiduciary retirement fund managers to consider ESG factors in their investment decisions, including climate change and corporate governance. Republicans have dubbed the move "woke capitalism" and see it as a reflection of liberal political influence in business. President Biden has said he will veto the bill if it comes to his desk, marking the first veto of his presidency. Buoyed by the results of November’s midterm elections, Republicans have vowed to use their new clout in Washington to attack ESG investing policies. Republican critics say that the Labor Department’s rule undermines 401(k) retirement funds, allowing investment managers to prioritise ideological issues such as climate change ahead of investment returns. However, Democrats have pointed out that the Labor Department rule is voluntary, freeing fund managers from the Trump administration's rules that limited their investment decisions only to what would generate the highest returns. The anti-ESG campaign has been supported by conservative advocacy groups with links to wealthy GOP political contributors and fossil fuel companies.

ESG investing has experienced considerable growth up to this point, but with growing resistance it may leave some investors considering whether or not the strategy will stand the test of time.

What's Next for ESG?

As always, it is impossible to predict the future, especially when it comes to the markets. However, regardless of where you sit politically, it would appear that ESG finance is here to stay. ESG is expected to reach $33.9 trillion by 2026, representing 21.5% of total assets under management according to PwC. There are several reasons why ESG investing is not a short-term fad but a long-term trend. The demand for sustainable investment funds is led by investors of all sizes, including institutions and individuals. Over $500 billion flowed into ESG-integrated funds in 2021, and even with antagonism being stirred up from the right, this trend is expected to continue.

Technological advancements are driving product innovation in sustainable investments. The development of artificial intelligence (AI) is enabling fund managers to analyse a large amount of data and provide better insights into how companies are run from an ESG perspective. This has resulted in a significant improvement in corporate transparency and the creation of new sustainable investment strategies. Companies are also being encouraged to act on ESG issues. Many companies recognize that they can only deliver sustainable long-term growth if they manage the Earth’s resources prudently, treat their workers with respect, and protect the natural environment. Corporate engagement is essential to encourage companies to act where the greatest impact can be achieved, and governments also have a key role to play in supporting sustainable investing.

Investment research is increasingly focused on sustainable outcomes; hopefully making ESG more uniform and intuitive to measure. ESG research frameworks are being developed and refined to support the growth of sustainable investment management. Companies that are developing climate change solutions and enabling the transition to a low carbon economy are being identified, and engagement with environmental laggards is being prioritized. Moreover, the energy transition is creating new risks and opportunities for investors. Resilience and competitiveness are critical factors in determining which sectors, countries, and regions will thrive as the world moves towards a low carbon future. Countries that can take advantage of the advances in technology needed to reach net-zero carbon emissions will be best positioned to flourish in this environment.

There are still obstacles to overcome, but new ways to capture sustainable returns are being developed every day. As more companies are committing themselves to sustainable business goals, it makes it possible for investors to mitigate ESG risks in their portfolios while also contributing to positive change.