Navigating ESG's evolution

ESG may have become mainstream, but along with that progress has come extraordinary scrutiny. 

The good news is that the perception of ESG factors being fluffy and irrelevant is decades out of date. Instead, investors explicitly factor in ESG, and dedicated professionals have increased in number. Assets in funds claiming to be sustainable or ethical have grown significantly in the last five years.  

Asset owners are now aware of the influence their capital has in the real world, and they’re more vocal about the values they expect to apply to their portfolios.  

If only that were the end of the story.  

A great divide

For the past few years, debate has simmered over the role companies and investors should have in tackling social and environmental agendas. Much of the challenge has been politically motivated, but there are legitimate questions. 

For example, opinion is divided over whether asset managers should screen out fossil fuel companies or champion a climate-change agenda. Some believe this is beyond their brief. 

We have also seen plenty of greenwashing, where firms make unsubstantiated eco-friendly claims, and even “greenhushing” – failure to disclose ESG integration in the investment process.  

There’s little sign of rifts healing, and ESG now offers a very real complication for the asset management industry: we cannot be all things to all people. 

A regulatory and political tangle

A patchwork of regulation is emerging as rule-makers in different regions attempt to promote, prevent, control, and clarify ESG claims and products. 

I worry about the mixed motivations and immaturity of regulation. Pursuing an ideological agenda via finance without a well-established regulatory regime seems ill-fated. 

Meanwhile, geopolitical stability is badly fractured. For example, Russia’s invasion of Ukraine has led to a rally in traditional oil and gas stocks – a real poke in the eye for growth managers who see long-term challenges for these companies’ business models. Post-Paris, were we mistaken to think the world would wean itself off fossil fuels? 

It seems ESG is pushing capital markets to their limits. Corporates feel overburdened by the expectation that they should represent all stakeholders. Institutional shareholders are expected to invest one way, while the markets still operate in the pre-Paris paradigm.  

So where are we with ESG? Is it working? Is it over? 

Growing pains, not death throes 

My view is that these are growing pains, not death throes. During my career, I have seen two major shifts that I think underpin real change – the first social, the second environmental. 

The first was the global financial crisis, when we saw that banking executives could not reap vast rewards with flagrant disregard for society at large – since society at large had to pick up the cheque.  

Ten years after the crisis, the Business Roundtable “redefined” the purpose of a corporation, saying it must act on behalf of all stakeholders, not merely grow earnings. To succeed, companies need support from the communities they affect and the wider public. 

The second shift is climate change. Scientific evidence shows the planet is warming due to emissions. The consequences of this for businesses may be profound.  

The key is balancing this with return expectations, and investing in companies that can capture the opportunity, from battery makers to drought-resistant seed manufacturers. Investors should also factor in the significant headwinds companies may face if they don’t move with the times.  

Doing what we say, saying what we do 

Our industry exists to deliver returns. That is a social good in itself. But as investors, we also have a responsibility to support society more broadly.  

I view these elements as complementary, and draw four conclusions.  

First, we must remain focused on opportunities for our clients.  

Second, investors should aim for meaningful engagements with the companies they hold.  

Third, we should focus on tangible outcomes rather than getting lost in the weeds. ESG is in danger of becoming an industry of box-ticking. We should favour thoughtful analysis over trivial data. 

Finally, we must inject some much-needed honesty into this debate. Investors can’t impose a particular ideology, but we shouldn’t shy away from transparently addressing ESG topics with companies when they are a material investment factor.  

ESG is complex and still finding its feet. At times, it will challenge the status quo. We should be excited – there’s a huge opportunity to invest in enterprises that can both solve society’s problems and succeed financially.  

Catherine Flockhart is a partner and head of ESG at Baillie Gifford. She oversees the firm’s ESG function, encompassing research, stewardship, voting, operations, and communication.