ESG Isn’t a Noun; It’s an Adjective

Think Tank

4 min read

Mark Goyder is a senior advisor to the Board Intelligence Think Tank. He’s the founder of Tomorrow’s Company and co-author with Ong Boon Hwee of Entrusted: Stewardship for Responsible Wealth Creation.

Imagine being told that the evidence is now overwhelming that eating more food contributes to longer life.

If you are suffering from malnutrition this is of course true. If, on the other hand, you live in comfort and don’t bother to take any exercise, it is probably not true.

And if your diet is unbalanced with too much sugar and salt and carbohydrates, it is manifestly untrue.

The problem lies in the generalised nature of the claim. What is meant by “more”? How do we define “longer life”? And how do we define “food”?

No right-thinking person would waste five minutes on such a claim.

Now consider the world of investment, where the FT in February, reporting Morningstar data, told us that:

“Rising demand prompted managers to change the strategy or investment profile of 253 European funds in 2020, helping to push regional assets invested in funds with an environmental, social or governance tilt to a record €1.1tn by the end of December, data from Morningstar show. In addition to the repurposed vehicles there were 505 new ESG fund launches in Europe over the year.”

This led to a warning issued in the FT last week by experienced fund manager Stephen Beer. He fears that there is a bubble in ESG funds:

“Longstanding ESG fund managers . . . should compare experiences with managers of technology funds at the beginning of the dotcom boom over 20 years ago.”

Fund managers, he counsels, should not neglect their basic task — identify investments that will deliver value. Be very wary of fashion.

Stephen Beer’s warning may upset some. Isn’t the world tilting towards a more human view of investment? Unless we learn to nurture the planet and our environment, there will be little economic value to invest in. Isn’t it time to tame this insistence on shareholder primacy in the interests of the planet? Don’t we need more companies committing to sustainability and ESG?

Furthermore, hasn’t it been shown that boards and CEOs who obsess over immediate share price do less well than CEOs who lay the foundations for long-term success?

The problem lies in loading all our expectations onto ESG — an umbrella term for a cluster of different concerns. As such it means different things to different people — especially in investment.

ESG (Environment, Social, and Governance) has become a marketing label for investment funds. Yet, it was never intended to be a conceptual foundation for a distinctive investment approach. Nor does it embody all those elements which an investment analyst is looking for in assessing future value creation: quality of management; corporate culture; brand, reputation; the spirit of a company.

Some people equate ESG with responsible investment; some with sustainability; some with a longer-term investment approach; some simply with their ideal of what a “good company” looks like.

Try looking for a workable definition. You won’t find one. Most people use ESG as an adjective. They talk about ESG factors, ESG issues, ESG value-drivers, and ESG integration.

Let’s go back to the beginning. The term ESG emerged from a report published in 2005 by the UN Global Compact entitled “Who Cares Wins.” A conference was held that year in Switzerland hosted by the Swiss Foreign Ministry and organised by the UN Global Compact and International Finance Corporation (IFC). The conference report described the ESG field as “quite new and avant-garde.” The report shows that all the pioneers were there — some of them, like Colin Melvin of Hermes, fresh from their involvement in the Tomorrow’s Company Inquiry on Restoring Trust — Investment in the Twenty-First Century.

Tellingly, the conference was entitled “Investing for Long-Term Value — Integrating environmental, social and governance value drivers in asset management and financial research.”

Some participants foresaw already the need for consistency of data from companies, which could be achieved by mandatory reporting requirements. The clearest conclusion was that participants wanted to see ESG permeate the mainstream of investment. One participant remarked that “pigeonholing ESG as a separate category will kill it.”

So, here is the puzzle. On the company side, sustainability reporting requirements are well on their way to being codified. And, although the ESG label is occasionally used, the most successful efforts are those which have a clear and specific focus such as carbon reporting.

In the fund management industry, meanwhile, ESG is becoming just what the pioneers feared — a fashionable investment category. It was intended to do the opposite — to be integrated into mainstream investment. It is simply an ever-widening list of factors that society needs to care about, that a growing number of savers and investment clients do care about, and that a future economy and its investment system needs to value properly.

What are we to do? I would commend starting with these recent words from Arkadiko Partners, the organisation which Colin Melvin, one of the pioneers of ESG 15 years ago, now leads:

“Many investors see new disclosure requirements on sustainability and stewardship as either a compliance exercise or an opportunity to label new products rather than recognising and embracing the real motives behind these regulations. The true task is for the investors to realise their interdependence with their stakeholders and to attend to what matters most for the long-term sustainable growth of our economies.”

I call that stewardship. Now there, unlike ESG, is a thing we can define. And it’s a noun!

  The Fairer Future inquiry    Find out what keeps our community of business leaders awake at night, and what  it will take to create a fairer future for all. Download the report

What you need to know, when you need to know it

Register for our newsletter to get a monthly compilation of our latest chair interviews, governance research, and upcoming webinars and events, along with weekly round-ups of the top news that matter to board members.