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The two sides of ESG

9 September, 2022

Frequent readers of Friday 5 will know that we talk a lot about ESG investing – the positives, the negatives and all in between. So we were interested in a recent article in the Financial Times that describes ESG (Environment, Social & Governance) as inherently flawed due to its dual and conflicting meanings from the outset.  

One definition of ESG adopted by portfolio managers, analysts and data companies is “taking environmental, social and governance issues into account when trying to assess the potential risk-adjusted returns of an asset”. In other words, looking at ESG inputs in relation to the value of an asset. And by this definition, Stuart Kirk declares most funds are “ESG” funds, as for example poor governance or corporate culture will always influence valuations, at least to some degree.  

The second definition of ESG is largely aligned with how consumers have come to understand the term – investing in “ethical” or “green” or “sustainable” assets. For example, divesting from companies that burn fossil fuels, and instead investing in renewable or cleaner energy sources. In other words, assessing the ESG outputs of investments.  

And Kirk’s right to point out that these two very different definitions fundamentally alter how ESG is implemented across the finance sector, how it is regulated, and how it is perceived by consumers. But this isn’t to say we should just throw ESG out the window because the exam marking criteria isn’t right.  

It’s clear there’s no point comparing apples with pears. As a solution, Kirk suggests that we need to split ESG into two: a designated range of ESG-input funds which are measured in reference to their valuation. And agree standardised scores such as emissions totals, instead of loose undefined terms such as “green”, for ESG output focused funds.  

If we can get this right, there may be light at the end of the ESG tunnel yet.  

By Budd Nicholson

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