Critics of ESG investing should take a closer look at the concept (2024)

As a formal metric, ESG is relatively new, but human societies have lived with its ideals for centuries. Critics cannot claim that ESG is not needed. It’s essential to understand that it’s not merely a static set of measures, but a dynamic concept driven by changing societal, environmental and governance priorities.

Capitalism as an economic and social system has evolved over centuries, but its modern form—often associated with features like private property, markets and limited government intervention— became prominent in the 18th and 19th centuries. It gained momentum during the Industrial Revolution and the rise of market-oriented economies in Europe and North America. Capitalism in its currently recognizable form is a few centuries old. To confront it without falling into the trap of ESG-washing, ESG frameworks must evolve to address its very roots.

Abandoning ESG is the easiest path, but it won’t resolve the larger question of whether capitalism can be harnessed for a more purposeful and sustainable future. A recurring theme in criticisms of ESG is the perspective that shareholders must always be the primary beneficiaries. While shareholder value is undoubtedly a vital aspect of business, it’s not the only one. To create truly effective ESG frameworks, we must transcend this singular view and acknowledge the broader spectrum of stakeholders whose interests must be considered.

Embracing the concept of stakeholder benefit is crucial for developing ESG frameworks with an objective lens. It’s a shift from a myopic focus on short-term profits to a more comprehensive approach that takes into account the interests of employees, customers, communities and the environment. For critics of ESG who stubbornly cling to the belief that only shareholders and immediate financial returns deserve all our attention, it seems they’ve thrown the essence of shared values, societal well-being and the long-term view of our planet’s future out the window. How do we ensure that our actions today don’t rob future generations of what nature has left for us and what we, in turn, will leave for them ? In their relentless pursuit of shareholder supremacy and profit-making, we risk undermining the broader values that should guide our economic decisions and moral responsibilities as stewards of this planet.

ESG’s modern journey began with a noble objective: to measure the ‘goodness’ of investments, primarily guided by the United Nations’ principles for responsible investing. But then, in a capitalist frenzy, many have pushed the questionable narrative that ESG could deliver higher returns without added risk or any gestation period.

However, as critics draw attention to underperforming sector funds and dodgy risk claims, they risk missing the forest for the trees. ESG’s evolution is not a departure from its principles, but rather an adjustment to emphasize the disclosure of material issues. While this evolution may seem like a convenient defence, it also mirrors our changing world and evolving priorities in the investment landscape. For example, one should wonder if regulations did not exist for granular disclosure on many subjects, how many corporates would willingly disclose them in good faith ? It does not make regulations bad.

A common criticism targets the belief that enhancing ESG universally will increase company value. We must acknowledge that different industries and markets respond differently to ESG criteria. Some firms gain in value with higher ESG scores, while others may incur costs without a corresponding boost in revenue. However, dismissing ESG based on anecdotal evidence overlooks its ability to encourage sustainable practices, foster innovation and create long-term value.

Another critique challenges the integration of ESG with investment processes, arguing that it contradicts itself by potentially lowering expected returns. The flaw in this argument is that ESG isn’t solely about risk reduction; it’s about identifying and managing the right risks, which can lead to better returns. Critics also highlight selective applications and geographical disparities in ESG pressures, especially for publicly traded companies. While this is a valid concern, these issues can be addressed and improvements made.

The argument that ESG has failed to significantly reduce our dependence on fossil fuels is indeed relevant. However, it has also catalysed the conversation around sustainability, and that matters.

All evolution has sceptics, but progress is driven by those who dare to question the status quo. ESG isn’t the problem; it’s the solution in the making. Don’t dismiss it. Refine the framework. Its mission is too important to give up on. We don’t have Plan(et) B.