As we look back on 2023, one of the most significant events of the past year was the demise of ESG investing. Or, to be more precise, the end of the term itself. That’s a good thing, because it will open the way to greater clarity and accountability about investment risks.
The term ESG has been a catch-all for a range of issues, from climate change to diversity practices, and has given rise to a confusing collection of standards, frameworks and rating systems. And the governance dimension (the “G” in ESG), which traditionally focused on director independence, board quality and executive pay discipline – has almost disappeared from the discussion entirely.
Thanks mainly to Larry Fink, CEO of BlackRock, the term “ESG” is on the decline. He conceded in June that he no longer uses the term because it has become politicized, drawing fire from conservatives who see it as an effort to favor liberal causes. Fink now focuses on specific factors, like climate risk, in BlackRock’s investment process and board engagements.
Over the past year BlackRock and other managers suffered the loss of a few high-profile pension mandates in red states over their ESG approach. But state efforts to pass legislation to bar investment firms that use ESG criteria or disallow ESG considerations in state pension funds have produced a backlash of their own, as pension officials argued that the restrictions would harm the funds’ investment returns.
Their argument is a bit ironic, since for years many investment funds dismissed ESG considerations, arguing that their obligations as fiduciaries meant they must focus only on material risk factors that could affect a company’s performance. Today, these investors recognize that climate change and other sustainability issues do present material risks and it would be imprudent to ignore them.
In fact, when you look past the headlines, a growing awareness of these risk factors continues to drive investor behavior. A recent report from Cerulli Associates found that despite the anti-ESG sentiment, asset managers are incorporating ESG criteria in their investment process and will keep offering sustainable-investing products to their clients.
All of this seems likely to prompt companies to be more explicit in their risk discussions and asset managers to be more transparent in how they evaluate companies and market their sustainable investing products.
Bringing more clarity and discipline to an area where it has been lacking is a welcome development indeed.