ESG is huge and terribly flawed. Now what?

This article originally appeared on Climate & Capital Media and is reprinted with permission.

The rapid and widespread adoption of ESG-focused strategy throughout the investment industry has created a strange dilemma. Having generated a $35 trillion global market, ESG advocates are in the ironic position of justifying its promise after the fact. In the wake of huge market buy-in, even the basic definition of ESG is unsettled: The rules and regulations governing ESG operations are very much a work-in-progress. Standards vary in method and aims, data is inconsistent and multiple ratings offer conflicting scores.

The red-hot rush to bring ESG products to market has been followed, predictably, by a firehose of cold-water questions.  

A report by InfluenceMap, a London-based nonprofit, evaluates 593 equity funds with over $256 billion in total net assets and finds that “421 of them have a negative Portfolio Paris Alignment score, indicating the companies within their portfolios are misaligned from global climate targets.” Climate-themed funds fared as badly: More than half failed to match the goals of the Paris Agreement. In sum, 55 percent of funds marketed as low-carbon, fossil-fuel-free and green energy exaggerated their environmental claims, and more than 70 percent of funds promising ESG goals fell short of their targets, concludes the report.

“As the number of ESG and climate-themed funds has exploded in recent years, so too have concerns among investors and regulators about greenwashing and transparency,” Daan Van Acker, an analyst at InfluenceMap, told Bloomberg.

Some companies have simply re-branded older, existing funds as green in name only to cash in on the ESG trend, reports the Wall Street Journal. “Last year, companies that manage mutual funds and exchange-traded funds rebranded a record 25 funds as sustainable, according to Morningstar. They say these funds have adopted investment strategies that utilize data on companies’ ESG performance to pick stocks.” 

ESG has even been termed a “dangerous placebo” by BlackRock’s former chief investment officer for sustainable investing, Tariq Fancy. He considers ESG a “distraction” from the leadership that should come from government policy and has little patience for the marketing of current ESG products. “If you are actually doing something that’s slowing us down under the guise of responsible business, you need to be held accountable,” he told Capital & Climate Media.

Accountability is focused on DWS, the asset management division of Deutsche Bank AG. The firm is facing accusations that it has overstated the green qualities of its ESG funds under the leadership of its former global head of sustainability, Desiree Fixler. The firm is the subject of investigations by American and German regulators. The case has triggered concerns about greenwashing throughout the investment industry.

Even the Feds are getting into the picture: The SEC has formed a task force to investigate sustainability claims, focusing on ESG issues.

What it means depends on your perspective: The scrutiny does show serious skepticism about the authenticity of some ESG claims, but it also means intense interest in ESG concerns even if some efforts are fairly flawed or fall short.

Even many ESG critics admit that the concept can play a beneficial role in pushing investment toward addressing climate change. As sustainable finance veteran Hazel Henderson put it when speaking at a recent TBLI event: “ESG is necessary.” But, she was quick to say, “it’s not sufficient.”

So there’s work to be done to raise ESG reality to the level of its promise. 

Continuing to refine ESG investment strategies (note the plural — there are and will continue to be several ESGs, I believe) and accountability is the name of the game going forward. Will there be a new and improved ESG as a result of these stress tests? Most probably. ESG’s very flexibility as a process, not a product, also offers a potential cornucopia of benefits. One foot in front of the other, a step at a time, may not be a sexy strategy, but it might be the only way to turn the lofty concept into a grounded reality.