Over the past year, critics of ESG investing [1]have issued dire legal warnings claiming ESG may be “inconsistent with financial interests.” A presidential candidate and a prominent media outlet identified, without evidence, diversity efforts as a factor in Silicon Valley Bank’s stunning failure. Skeptics, from opponents of DEI in the workplace to industry players with clear agendas, such as oil and gas companies, have argued that ESG is undermining fiduciary duty. Meanwhile, advisors are left to make sense of the cacophony.

But they should be bold in addressing these issues with clients because the false narratives driving the ESG backlash ignore prominent components of reality. Climate risk is manifesting in real time. Diverse management teams outperform their more homogenous counterparts. And the next generation of investors wants genuine options to invest sustainably. As investment professionals, we must use facts with our clients and help them understand what is happening in the marketplace. Here are a few key messages to focus on.

The business debate over the merits of ESG has shifted.

Despite the recent outcry, most US CEOs view ESG as a value driver for their businesses over the next few years. At the state and local levels, a recent Wharton School of Business study linked Texas’s anti-ESG law to a $532 million loss due to higher interest payments on municipal bonds, increased investment expenses, and fewer options for state pensions. With data and demand in support of ESG at the public and private levels, legislators, companies, and investors can no longer get away with sitting on the sidelines. There are no more sidelines.

The push for diverse managers is changing the game.

Serious investors understand that helping more women and people of color rise through the ranks and succeed benefits corporate decision-making. The most tangible way the diversity debate plays out in our field is via momentum for investment managers with diverse teams. Diversity is a component of ESG-related criteria and a demonstrated factor influencing performance. And yet, according to the Knight Foundation, only 1.4% of the money managed in the United States was managed by diverse-owned firms in 2021. But that is poised to change.

In a survey by Morgan Stanley, three-quarters of public pension-fund-asset owners reported that investment teams with women representation “significantly improved the performance of their investments.” Nearly two-thirds said the same of teams with multicultural representation.

At the same time, investment consultants in charge of allocations are increasingly building diverse manager searches into their practice. Wilshire’s Diverse-Owned Manager Initiative reports that the number of clients investing with diverse-owned firms has doubled (to 21%) while the number of consulting meetings with diverse-owned firms has grown annually by 23%.

It is becoming more challenging to get away with greenwashing.

‘Greenwashing’—making claims to appear sustainable despite lacking notable efforts or concrete investment to support them—is ubiquitous in our field. The indiscriminate use of ESG buzzwords, plus the historical lack of standard ESG terminology and key performance indicators (KPIs), has made it difficult for investors to trust the authenticity of ESG strategies.

But there’s a silver lining for authentic ESG managers. The intense focus on ESG has advanced the debate by defining more explicit greenwashing standards for managers and the marketplace. Pending rules by the SEC in the U.S. and Sustainable Finance Disclosure Regulation (SFDR) in Europe may cause a due diligence headache, but they have put managers on notice. By establishing standards defining sustainable investing, these efforts help distinguish authentic ESG investment managers from those merely marketing ESG products to customers. There is a difference between those who recognize ESG criteria as vital to investment decision-making and those who see a market opportunity to take advantage of while it’s in favor.

None of this progress happened by accident. Significant organizations, large pension funds, and investment consultants demand higher standards for defining ESG practices. Client demand is making diverse manager searches a standard practice. In the years to come, teams of investment managers will be more transparent and more varied—and that will be reflected in their investment decisions.

It is not a “woke mob” that is embracing ESG. It is companies and Boards. It is investment consultants. It is employees and customers. Investors want companies to address the fundamental challenges of our society and planet. Companies increasingly recognize that embracing ESG positively influences the bottom line. That is the true story about the impact of ESG.

 

[1] Environmental, Social, and governance (ESG) investing is an investment philosophy that combines a comprehensive understanding of the impacts of ESG criteria with traditional financial research to help identify companies exhibiting long-term drivers of success.

Published On: September 19, 2023Categories: From the Commons