ESG shows that free markets work

ESG shows that free markets work

What started a few months ago as isolated environmental, social and governance (ESG) criticisms has now exploded into a reactionary reaction. This dangerous rhetoric is now turning into politics, especially in states like Florida and Texas, with very real and very negative ramifications for investors.

To understand how this happened, one must understand why ESG is practiced and why it has become so widely adopted. Investors, many of whom are signatories to the Principles for Responsible Investment, consider responsible investment factors because they know they can be important to the value and performance of investments.

There should be no controversy about investors considering the facts. Mainly, the fact that climate change is real and poses a growing threat to the long-term feasibility of investors’ current holdings. For example, the increasing frequency and magnitude of weather-related risks are driving up insurance premiums on coastal properties around the world, making some properties completely uninsurable. Investors should have the tools they need to fully consider relevant factors like these when making long-term investment decisions.

With this in mind, asset managers have a fiduciary duty to their clients to push companies to improve their corporate governance and asset owners should feel empowered to require their managers to invest in accordance with their investment objectives. This kind of active ownership has long been a way for investors to pursue their views on investment risk and return. Recent trends in active ownership around ESG issues are not the result of some sinister hidden hand, but rather a natural evolution of the market, which reflects the fact that investors increasingly recognize that ESG risks and opportunities influence the value of investments.

There are valid critiques of ESG investing and we should be prepared to discuss those critiques and find a productive solution. But too often, the criticisms we see today are not based on facts. ESG critics, who want to make sure investors are clear about their goals and how to achieve them, raise an important point. But limiting the ability of investors to do their job by prohibiting or discouraging the practice of ESG is not the right path. Rather, the focus should be on making ESG work better, as this adds up to positive investment outcomes.

Many have focused on issues such as rating systems and index funds with ESG in the title while ignoring politics and advocating for better access to information. As Los Angeles Times columnist Michael Hiltzik said, ESG is the new CRT. Like the acronym that precedes it, critics are more concerned with their personal definition of the term and how it fits their argument, rather than actually engaging with its content. People should be equally skeptical of using ESG criticism as a means to sow political division.

Herein lies the rub with the growing anti-ESG backlash: the attacks on sustainable investing and its proponents have a hole where their facts should be. For decades, asset managers and asset owners around the world have sought more information as their investment analysis and market experience has led them to conclude that ESG factors can be material. The increased transparency brought by the new disclosure rules is a great example of what ESG is really about: clear, consistent and comparable information that cuts through the chatter.

The fact is that it is investors who are calling for increased disclosure requirements and policies that promote transparency, because those are the kinds of tools that investors need. Allowing them to make more informed choices should be something of proponents of an efficient and free market, but many critics of ESG seem opposed to the idea of ​​letting investors pursue what they think is at their best. interest.

One explanation is that, beyond sustainable investing being a useful policy target during election season, many ESG critics show a protectionist instinct toward certain industries, such as fossil fuels. They view ESG investing as a threat. Fossil fuel investors fear that consideration of climate impact – increasingly becoming a focus for investors – will hurt their portfolios. Many ESG critics are so entrenched in their views that they are willing to abandon free market principles in an attempt to end the practice.

ESG is now sufficiently important and influential to make it a target. But the reason it is widely used by investors is because it benefits them and their clients, and not because of any grand conspiracy or partisan pressure. The widespread use of ESG is a sign that markets are working and that investors are fulfilling their fiduciary duty. Investment practices will continue to evolve and adapt, and ESG critics should engage with these changes in a meaningful way.

Nathan Fabian is Director of Responsible Investment for the Principles for Responsible Investment.

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