Making investment decisions on the basis of a company’s record on environmental, social and governance (ESG) matters has provoked a backlash from some investors and politicians. The underlying issues are surprisingly complex
The business and financial sections of news media used to be rather dry and technical, not directly affected by partisan political activism. That has changed in recent years. The idea that investment managers should seek to ensure that the companies they invest in are responsible, in social and environmental matters, has grown. The abbreviation ESG, for environmental, social and governance issues, with associated rankings, has become more common.
Conservative commentators have protested. They make the case that the purpose of asset managers is to exercise good investment returns – not engage in political activism with other people’s money. The backlash has been particularly strong in the US, where some Republican-run states have disinvested in ESG funds, and investment managers promoting them, arguing that it is a ‘woke’ agenda. Some 18 states have passed legislation banning discrimination against investing in fossil fuel or arms companies.
In terms of respecting the fiduciary duty of investment managers, the critics of ESG-guided investment have a point. There is a counter-argument, however, which is that a good ESG rating can be viewed as a proxy for sound governance and sensible strategy. Many writers advocating the approach are relatively conservative (with a small ‘c’) academics in the Harvard Business Review, not activists from the left of politics. Where things have become complicated is that some funds with high ESG ratings have not produced good returns in the past couple of years.
It is possible to view the issues as complementary to more conventional assessments of a company’s prospects; to see a good ESG rating as necessary, but not sufficient, to qualify for investment. Moreover, a narrow focus on the financials can become too short-term: If investment is curbed to boost short-term earnings, this can ultimately lead to declining company performance. A strong ESG rating may be an indicator of a longer-term perspective, but sensibly needs to take its place alongside rigorous assessment of financial health, calibre of management, company strategy and prospects.
There are technical, as well as political, issues regarding ESG as an indicator. There is no agreed, universal standard, and there are different agencies that provide a rating, using different methods. They are restricted to information that is in the public domain – statements by the company itself, court rulings and media reports on matters such as minimum wage or environmental breaches. Also, the three categories are quite different from each other, so they are not obviously well-represented by an aggregated ranking.
Then there is climate change: The argument for taking it into account as an investor is that the risk is of a different nature and dimension to others; it threatens severe upheaval to just about any business model over the longer term. Encouraging net zero policies is a rational consideration for investors, many argue, not a political choice, especially those with a long-term horizon, such as pension funds.
Extreme weather events and changes to climatic conditions are already affecting the insurance sector, tourism, and agriculture. High temperatures in southern Spain, for example, have led to warnings from scientists that olive oil production is likely to fall by 30% owing to higher temperatures and drought – warnings that were made even before the drought and high winter temperatures recorded this year. In summer 2023, tourism bookings fell and flight cancellations rose in the Mediterranean after wildfires destroyed large areas of forest and housing in Greece, Italy, Tunisia and Algeria.
For all the heat of partisan debates over ESG-related investments, the impact of the political controversy on investment decisions may be limited. A report on the issue by the Financial Times in December noted only a small impact of disinvestment campaigns by conservatives. High-profile fund managers such as Larry Fink of BlackRock are less likely to boast about taking environmental considerations into account compared with a couple of years ago, and ESG indicators may be subject to more rigorous scrutiny, but the environment itself will dictate certain shifts in investment, and there will always be pressure for transparency on labour and environmental matters.
The Qatar National Vision 2030 underlines the importance of social and environmental responsibilities. The 2022 FIFA World Cup was carbon-neutral, and both the Qatar Financial Market Authority and the Qatar Stock Exchange encourage listed companies to report on their ESG actions.
Being socially and environmentally responsible is fine, indeed necessary, in public policy. The ESG rating may not work well as the primary guide for investing, but the underlying issues are not going to go away.
The author is a Qatari banker, with many years of experience in the banking sector in senior positions.
Fahad Badar
