ESG investing challenges and why ESG is failing many investors

Despite the promise of ESG investing, a number of ESG investing challenges are surfacing as the approach gains wider interest across the investment industry. Environmental, social, and governance (ESG) emerged from the United Nations (UN) attempt to coalesce a multilateral agreement around a set of principles and corporate values to achieve sustainability goals. This framework has been evolving since the first sustainable development goals were agreed upon in 2015.  Similarly, ESG investing policies and objectives continue to evolve. 

Originally many investors screened out companies based on specific criteria or engaged in these investing challenges.  Now many investors try to proactively invest in companies that have a positive impact.  The European Union Directive on Non-Financial Disclosure further underscores investors’ shift toward supporting companies with businesses that contribute to environmental and social good.  While these trends are positive, investors face many head winds in shifting their investment portfolios to meet personal environmental and social goals, plus companies need time implement changes.

Despite the labels, funds aren’t delivering

Despite clearer definitions, standards and guidelines, investors remain challenged and a number of ESG investing challenges are becoming evident. Investors are struggling to understanding how investment funds incorporate their ESG principles and goals in their portfolios. For example, InfluenceMap recently reported that of 593 equity funds falling into the broad ESG category, 421 (71%)  scored negatively on Paris Alignment, which means their portfolios were contrary to global climate targets.  This, in turn, has led to an increased claims of “green washing” across the industry and a general climate of increasing ESG skepticism.

Another area with ESG investing challenges is with index providers. ESG index providers are doing a relatively poor job of identifying ESG-focused companies, because they focus on ESG risk ratings, which assess the probability of an ESG issue affecting a company’s financial condition rather than understanding whether a company is pursuing robust ESG operating efforts or if a company is adversely effecting its environment. For this reason, passive strategies are widely being called out for having a negative impact on climate change and preventing social and governance changes.

Having a positive impact in the interim

Individual investors, especially millennial individual investors, want their portfolios to make a positive impact on society, but the impact is difficult to measure or allocate to individual investors within investment portfolios.  One way to achieve environmental goals in the short term is to contribute to carbon mitigation projects through the purchase of carbon credits and avoid ESG investing challenges entirely. 

Carbon credits are just one form of credit.  Registries also offer plastic and water credits.  Given InfluenceMap’s fund-level findings and inefficiencies associated with changing investments in post-tax accounts, many investors may want to consider how credits or offsets could improve their impact.