* Any views expressed in this opinion piece are those of the author and not of Thomson Reuters Foundation.
The 1920s saw millions of individuals buying stock for the first time, just as 2020 saw new investors drawn to ESG investing.
Blaine Townsend is the advisory board member for The Journal of Impact and ESG Investing.
You don’t need to squint to see that 2020 was like a grim 100-year echo of 1919. Separated by a century, the two years shared racial strife, political instability and pandemics that killed over 500,000 Americans each.
Both also ushered in big changes in the capital markets. Following 1919, millions of individuals bought stock for the first time. 2020 saw a new crop of investors drawn to environmental, social and governance (ESG) investing.
Like 1919, the surge in ESG will lead to more standardized reporting and clarity for investors. In the meantime, ESG investors should stick with an old adage: buy the seller.
According to Bloomberg, over $117 billion flowed into ESG funds between June 2020 and June 2021. The inflows suggest that ESG offers something compelling to investors interested in climate change, diversity and inclusion and stakeholder responsibility. The strong ESG performance track record certainly helps, as did signs that the business community is willing to step up and take a stance on these issues.
Yet ESG is difficult to define.
At the company level, many of the most important ESG disclosures are voluntary and not standardized. ESG has grown so rapidly, that regulators have not kept up.
In 2010, then-Security and Exchange Commission (SEC) Chairman, Mary Shapiro, first offered guidance on how climate change fits into financial disclosure, but there’s been little follow-up since. That is changing.
Just this month, the Securities and Exchange Commission Asset Management Committee is set to vote on recommendations to enhance diversity disclosures and ESG reporting.
At the portfolio level, many asset managers rely on ESG scores provided by vendors. To bridge the gap of unreported or missing data, vendors create a sophisticated algorithm to predict data and the financial materiality of an ESG issue by industry. All of this can be opaque to the end investor.
The reality is that there is no simple definition for ESG. It has become the catch‐all term for a disparate and confusing range of investment strategies – from low carbon or clean tech‐focused to those skewed toward gender, diversity and inclusion.
ESG investors are not all alike. But they often are united in that they care about something in addition to financial returns.
At the moment, the best protection for ESG investors against greenwashing or a misalignment of their portfolio and their values is to understand the motivation or world view behind the firm, investment teams, fund strategy and due diligence process.
Here are markers that can help guide an investor:
- Alignment
Alignment of firm and ESG strategy with broader stakeholder work on environmental and social issues is a good place to start. For example, alignment between the investment process and the United Nations Sustainable Development Goals.
- Advocacy
The portfolio can’t be the only expression of ESG. There are numerous efforts to align asset management around things like human rights and climate.
- ESG process
Investors should understand whether they are getting a process based solely on vended scores, or whether the investment team has a more holistic and sustainable approach.
- The team
It often takes a unique combination of experience and orientation to create a strong ESG investing team. Traditional finance and investment acumen are important, as is tenure and commitment in the ESG and socially responsible investment space. Buy the seller.
For analysts looking to assess ESG at companies, there are also some markers to verify if a business is virtuous, or just virtue signaling. Trust, but verify.
Large companies with 100 or more employees in the United States compile information on the racial, ethnic and gender breakdown of their employee by category (as mandated by the U.S Equal Employment Opportunity Commission). Businesses can and should release this information to the public.
But what of Net Zero commitments? Is there one? Is there a specific target? Do they define how they plan to reach it? Do they report on progress?
The good news? ESG has worked, performing well and attracting assets at a higher rate than traditional Wall Street strategies in recent years.
The world and markets will emerge a bit different from the challenges of 2020 just as it did after 1919. Will the 2020s be a roaring good time, similar to the 1920s coming out of a pandemic? If 2021 is any indication, it will be for ESG investing.
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