Environmental, social and corporate governance (ESG) investing has become a hot trend in recent years. Many investment management leaders claim that a large portion of their assets are monitored through ESG metrics. People hope that ESG investing can make capitalism work better and deal with climate change threats. However, ESG is still facing problems. There are conflicts between different ESG goals, inconsistent scoring systems, and doubtful links between ESG performance and financial returns. To truly achieve sustainable investment management, we need to streamline ESG measures and focus on quantified emissions disclosure.
ESG sets conflicting goals for investment management companies
The fundamental problem with ESG is that it combines too many different objectives together. Improving environment, taking social responsibilities, and strengthening governance can sometimes conflict with each other. For example, Tesla’s CEO Elon Musk is known for poor corporate governance practices, but his promotion of electric vehicles helps tackle climate change. If a coal mining firm closes down due to environmental concerns, it would hurt its suppliers and employees. ESG scoring systems often ignore such goal conflicts, making it hard for investment managers to balance different priorities.
ESG scoring systems have low consistency for investment management analysis
Another major issue with ESG is the lack of standardized and consistent scoring metrics. Different rating agencies show little agreement on ESG scores for the same companies. But traditional credit ratings from agencies have a 99% correlation. Such huge inconsistencies make ESG ratings less reliable for investment analysis and decision making. Companies can also easily game the system by selling assets to improve scores without changing real operations.
Questionable ESG-performance link hampers sustainable investment management
Many ESG proponents claim that good ESG performance leads to better financial returns. But the evidence for such linkage is weak. In fact, companies that externalize costs to society through pollution often generate high profits. Thus, virtue does not necessarily lead to market outperformance. This makes it harder for investment managers to justify sustainable investing to clients seeking returns.
Focusing on emissions data can improve sustainable investment management
To truly achieve sustainable investment management, ESG measures need to be streamlined. The ‘E’ for ‘environment’ is too broad and should be narrowed down to quantify GHG emissions. Disclosing accurate and standardized emissions data will help investors identify high-polluting companies and reduce portfolio risks. It can also inform government climate policies. With better emissions transparency, investment managers and banks can track portfolio carbon footprints over time.
In summary, ESG investing faces problems like conflicting goals, inconsistent ratings, and unclear performance links. To serve sustainable investment management, ESG needs to be simplified into transparent, quantified emissions disclosure.