Whatever happened to ESG?

‘Did ESG and sustainable investing ever stand a chance of making a difference to the real world?’ Whatever happened to the ‘fleeting glimpse of investment nirvana’ that might once have been sloganised as ‘better returns and a better world’ — in which ethical investment as a moral choice might no longer typically produce lower returns than conventional stock-picking, but rather the reverse?

This would be a world in which well-governed companies which minimised environmental impacts, avoided sectors and places associated with sin and paid sincere attention to social issues would, in the long-term, outperform dinosaur competitors that failed to follow such virtuous tenets.

Previous waves of ethical exclusion had, for example, seen many investors shun companies active in apartheid-era South Africa. Others had long chosen to exclude armaments, tobacco and gambling from their portfolios. Codes of governance in relation to the make-up and conduct of public-company boards advanced in the 1990s from an irritation dismissed as ‘corporate correctness’ to a plain fact of company life. Thus ‘corporate social responsibility’ (as it used to be) had been evolving for at least half a century before a UN-sponsored report in 2004 gave birth to the acronym ESG, which rapidly began to gather momentum in boardrooms and business schools.

Not far behind came the UN’s sustainable development goals and principles for responsible investment, climate-related financial disclosure initiatives and much else that might be characterised with hindsight as the apotheosis of ‘Davos Man’, the archetype of the corporate and political elite who pontificated from the platform of their annual Alpine gathering.

For a time, the big money and the bien pensant thinking were largely aligned. ESG-themed funds became highly attractive to investors, growing from $500 billion to $3 trillion between 2018 and 2021 as they outperformed conventional collective funds. They did so by investing more in asset-light tech stocks as well as fashionable renewable energy ventures, and less or not at all in fossil-fuel and industrial sectors which had gone out of favour — so that the win-win greener world with richer returns seemed for a while to be a self-fulfilling prophecy. No public-facing investment institution could afford not to embrace the ESG creed, while companies from NatWest to Danone strove to declare themselves ‘purpose-led’. And many of the industrial and extractive businesses that were among the West’s worst polluters passed quietly, at bargain prices, into the hands of private equity.

So far so good, at least in the public investment arena. As Tom Nelson said, ‘the stars were aligning’. Until, that is, ‘all this came to a shuddering halt in 2022’. Why? The proximate cause was the Russian invasion of Ukraine, which caused inflationary price spikes in energy, grain crops and industrial materials. I take the liberty of quoting my own Spectator column from June 2022:

‘When millions of households face fuel poverty, the case for rapid disinvestment in carbon energy looks pie-in-the-sky. Why shun defence manufacturers’ shares when their products could save Ukraine? If millions more go hungry for lack of grain supplies, why withhold capital from responsible bioscience companies developing high-yield GM crops? There are immutable principles of decent corporate behaviour, there are desirable long-term social and environmental goals to be balanced against short-term exigencies, and there are passing whims and fads. The current state of the world is teaching us the difference.’

Meanwhile too, the S-for-social element of ESG had somehow run out of control. If protecting the natural environment and promoting good governance were by now embedded in responsibly run companies, the more nebulous social element of ESG had grown, as Nelson says, to confront investors with ‘a maelstrom of increasingly bizarre considerations’, which had little obvious impact on company performance.

And in the United States, corporate attention to the social issues of DEI (diversity, equality and inclusion) switched from a positive tick on the ESG report to a distinctly negative risk when Donald Trump returned to the White House for a second term and threatened, inter alia, to punish federal contractors that were deemed to be operating ‘illegal’ DEI recruitment policies.

Many US corporations rapidly backed away from both DEI and net-zero commitments, with investment managers such as Vanguard and Blackrock following suit — ESG and ‘sustainability’ funds having been relative under-performers since 2021. In the energy sector, shareholders generally applauded a return to fossil-fuel exploitation and a downplaying of investment in wind and solar projects. And as Nelson noted, the World ‘simply lost interest’ in the outcome of this year’s COP conference in Brazil, which was intended to advance co-operation to impede global warming.

So where next? Will ESG end up in the museum of corporate buzz-phrases alongside ‘stakeholder capitalism’ and ‘purpose before profit’? The gloomiest scenario sees the continued withdrawal from climate-change commitments in the West, and the relentless advance of Chinese industry, leading to increased warming and extreme weather events with consequent setbacks to global GDP — and an eventual Schumpeterian crisis of creative destruction from which new regimes and technologies might emerge.

A milder forecast looks forward to the end of what we might call the Trumpian aberration and the timely rediscovery by global corporations, in the interest of shareholders as much as customers, of the case for behaviour that reduces climate-related risks: a spontaneous return to ‘E’ as a matter of necessity, we might say, with continuing ‘G’ as a matter of good housekeeping but rather less emphasis on ‘S’.

Tom Nelson concludes by quoting the economist Duncan Austin: ‘Sustainability now looks much more like a moral obligation than a market opportunity.’ But only for now, perhaps. The pragmatic investment position is one that accepts ‘saving the world while outperforming’ was a pipedream but also recognises the folly of dismissing ‘ESG as rubbish and the energy transition as woke nonsense’.

So ‘buy good companies and good funds, follow good managers and keep an eye on nuclear fusion and carbon capture’, because the energy transition may have been knocked off course but it is the planet’s only viable long-term path. And in due time it will shine a spotlight on the winning technologies and new industrial giants of the next generation.

*Tom Nelson was Head of Thematic Equity at Ninety One, a global investment manager, and is a Senior Associate at Oxford Net Zero.

The views expressed in this article are those of Tom Nelson and Martin Vander Weyer and are intended for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument. The information contained in this document does not constitute investment advice and should not be used as the basis of any investment decision. References to specific securities are included for the purposes of illustration only and should not be construed as a recommendation to buy or sell these securities.