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The ESG debate is guilty of muddled thinking

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In a 2017 paper, I argued that the understanding of investment theory then - which seemed to frame the financial world as being almost entirely separate from the real world inhabited by ordinary investors and beneficiaries - was a significant factor that contributed to the 2008 financial crisis.

Scroll forward a few years and ESG investing has exploded into mainstream asset management. In that sense, the responsible investing approach long advocated by myself and a handful of others, I’m glad to say, has been adopted.

The industry has landed on an approach advocated by the “Father of Economics” himself, Adam Smith. While famous for arguing that “rational self-interest” and competition can lead to economic prosperity, it is less well known that in his Theory of Moral Sentiments he linked prosperity to the “preservation of society”.

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I think Smith would be pleased with how our industry has, at last, understood the link between long-term financial success and societal good. 

What he may be less impressed by is the wildly divergent, and often self-serving, opinions around the goal of sustainable investing or what constitutes a "sustainable asset". Coupled with accusations of greenwashing, we face growing cynicism today as to the effectiveness of ESG investing. 

Recently, we have heard a senior asset management executive in the UK complain about ‘climate change’ hyperbole. Russia’s invasion of Ukraine became a catalyst for accusations that ESG investing is a greenwashing ruse, unveiled through exposures to pariah state Russia. Compounding this, it is now also seen as impediment to energy security.

Herein lies our problem today. There is currently a lot of ill-informed debate and conjecture, where multiple issues are conflated under the bracket ‘ESG’, as if it is a one-size-fits-all approach that can be judged over any time horizon. 

It’s not. It’s a broad church - responsible investing, negative screening (removing the worst offenders), positive screening (for ‘best-in-class’ performers), sustainable investing and impact investing. It depends on investor preference.

And it’s about the long term. Climate change, and its effects, is upon us now. But mitigating today to avoid its worst long-term effects is fundamentally the right thing to do from an investor standpoint. Not to mention from a societal point of view.

But it is this issue of time horizon which starts to really infect the discussion around ESG and its effectiveness. 

As investors, it is our job to create wealth sustainably for beneficiaries over 10-plus years. And yet, the traditional track record put in front of investors, against which asset managers are often judged, is one, three and five years. Many investee companies are held to an even tighter timeframe, if they are listed, through quarterly disclosure requirements.

The discourse around ESG investing then gets wrapped into this instinct for short-term results.

While an investor may well deliver good returns in these shorter periods, the real impact from investing and engaging with investee companies really only starts to be seen over a much longer timescale. A period that absolutely has to consider adverse impacts on wealth caused by, for example, environmental and social risks.

The next big debate in our industry should, therefore, not be about the merits of ESG investing. To me – and most of our industry – it’s here to stay. But instead, over what timeframe are we really assessing ourselves? That of the self-imposed version applied by the financial and business worlds, or that of the ultimate end beneficiary?

If the latter, then they will benefit from investors who seek investment opportunities through long-term planning, include ESG factors alongside traditional financial ones, and undertake genuine engagement and dialogue with investee companies.

If your time horizon is shorter, then it is an entirely different debate.

Saker Nusseibeh, CBE – CEO, Federated Hermes

The ESG debate is guilty of muddled thinking

In a 2017 paper, I argued that the understanding of investment theory then - which seemed to frame the financial world as being almost entirely separate from the real world inhabited by ordinary investors and beneficiaries - was a significant factor that contributed to the 2008 financial crisis.

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Neil Griffiths

Neil Griffiths

Neil is the Deputy Editor of the wealth titles, including ifa and InvestorDaily. 

Neil is also the host of the ifa show podcast.

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