generic Why ESG Investors Put Too Much Emphasis on the Environment
Ever since it broke into the market mainstream in the wake of the Great Financial Crisis, environmental, social and governance (ESG) investing has only grown in popularity among institutional investors and allocators. Insatiable demand from some of the worlds biggest allocators has helped fuel the ongoing ESG boom across a host of asset classes.
In the equities market, ESG fund strategies have continued to gain popularity thanks in no small part to the efforts of the worlds biggest index fund manager, BlackRock Inc. (NYSE:BLK), as I have discussed previously.
ESG investing has spread beyond the equity markets, having taken the fixed-income market by storm in recent years. Global ESG bond issuance is expected to reach $1.8 trillion this year and may grow to as much as $4.5 trillion annually by 2025 according to data and estimates from the Institute of International Finance.
As the Wall Street Journal observed in November, fund allocations to environment and climate-focused investments have consistently dwarfed those directed explicitly toward the other two legs of the ESG tripod - social and governance. The social component, especially, has struggled to gain the attention and consideration it deserves from investors because it's difficult to measure and, let's face it, lots of big companies find it more profitable to ignore things like human rights. That needs to change.
A dimension that defies definition
Despite the flood of investment into ESG products and strategies in the last few years, most ESG funds and products are focused on the E of ESG, often exclusively. Environmental impact is a well-defined concept, as are the ways a green bond can show environmental impact, from carbon footprint and emissions levels to plastic waste and pollution.
The social dimension of ESG, by contrast, often defies easy definition. It's hard to just slap a number on it, like the number of trees or gallons of gas saved. Socially responsible investing has a broad and uncertain scope in the workplace. It includes things like closing the gender-based pay gap, company diversity, workplace inclusiveness, philanthropy, community impact, socially desirable actions, etc.
As it is both broad and vague, at least as compared to the other two dimensions, the social dimension of ESG has often been relegated to playing a supporting role in ESG funds. It is much the same story on the fixed-income side, with asset allocators continuing to focus on environment and climate-focused investments. Bondholders still have yet to identify a definitive set or factors that can distinguish a social investment and gauge its impact.
Bringing the 'S' into focus
Profound labor market issues have been building for years and were thrown into stark relief by the outbreak of Covid-19. Some of these workforce issues have gained the attention of policymakers and regulators, including the Securities and Exchange Commission. SEC Chairman Gary Gensler recently announced plans to formulate a "human capital disclosure requirement for public companies. Reporting metrics might include worker turnover, skills and development training, compensation, benefits and workforce demographics related to diversity, health and safety. While this would be far from a complete set of social metrics, they may help shape a more concrete definition of this most protean dimension of ESG.
To gain the full benefits of - and deliver the most impact through - their ESG investments, investors may have to embrace a more balanced approach to impact. They should start by taking the S in ESG investing more seriously, starting with companies treatment of workers. Consider, for example, the AFL-CIO Housing Investment Trust (HIT). The HIT is a fixed-income mutual fund that aims to make a major social impact through targeted investments in multifamily construction projects that use all-union labor. The measurable impact of investing in these sorts of focused mortgage-backed securities and construction loans is clear: they provide well-paying union jobs and much needed affordable and workforce housing in key markets.
My take
Having established itself as a dominant framework for institutional investors allocation strategies, ESG is clearly here to stay. Thus, investors of every stripe will likely have to engage with it in some shape or form eventually, in my opinion.
However, I would also caution investors that the proliferation of self-styled ESG funds and assets can make sorting genuine impact opportunities from cases of mere green-washing and other promotional schemes rather difficult. In my assessment, developing a more holistic approach to defining investment impact may help investors avoid such pitfalls and better achieve their impact objectives.
Trade carefully!
Disclosures: No positions.
This article first appeared on GuruFocus.
