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Fuzzy criteria means ESG is always going to be subjective

In brief
  • Environmental, Social and Governance (ESG) funds, synonymous with ‘woke’ politics, are losing favour.
  • They use subjective criteria and outcomes that are easy to game. 
  • Many investors don’t want companies that offer opinions on issues not central to their business, and are choosing financial results over ideology. 

‘Tree-hugging’ funds losing allure

Environmental, Social, and Governance (ESG) investing, often associated with social justice, may seem commendable, but it is just pushing a narrative. It is also known as DEI (diversity, equity, inclusion). Vague and subjective criteria, politicisation, and concerns of greenwashing cast doubts on ESG’s future with investors. 

Fuzzy criteria means ESG is always going to be subjective - Centrist
The building blocks of ESG are under scrutiny due to concerns about their subjectivity and authenticity.

Pejorative terms like ‘tree-hugging funds‘ and ‘woke capitalism’ are being used disparagingly. Increasing numbers of people view it as a passing trend and are gravitating towards practical, measurable outcomes rather than idealistic virtue-signalling.

Subjective metrics

One of the fundamental challenges ESG faces is the subjective nature of its assessment criteria. Critics argue that ESG’s wide-ranging standards, often based on feelings, opinions and fads, make it impossible to measure its effect on financial results.

This also means it is easy to write a report claiming ESG investing is more profitable. However, it is a fool’s errand to try to verify this for any number of reasons. Besides the overwhelming subjectivity, some say it hasn’t been around long enough to even try and measure short term versus long term success. There’s also the herd mentality effect where the investment goes up because investors are lured in by ESG promotion.

Such uncertainties have resulted in capital being withdrawn out of ESG funds.

There are also concerns that ‘fluffy’ metrics within ESG are easily manipulated by executives aiming for substantial bonuses. Incentives for vague, diversity hiring goals can be gamed. There are even instances of airline employees getting bonused after flights are cancelled for some other reason, because there was an ESG positive (i.e. less emissions), which dramatically illustrate these issues.

ESG: Politicisation of investing

The subjective standards of ESG investments have also led to the “politicisation of investing.” Some jurisdictions are taking steps to limit state investments or contracts with ESG-friendly companies. One reason for this is because the imposition of such standards on the company’s operations is effectively the use of assets, owned by others, to promote the politics of the decision makers.

In some cases, pursuing these political objectives can have definitive negative effects and may even lead to shareholder lawsuits. It’s prudent to be able to defend any ESG activity with the argument that there was some calculated win for the company, even if it is just better public relations.

Greenwashing and social responsibility

‘Greenwashing’ presents another challenge. Companies often flaunt their ESG compliance without addressing underlying issues, creating a dilemma of compliance versus authenticity. As Robert Jenkins astutely points out, when a fracker receives an ‘A+’ on environmental issues while a company like Netflix is rated ‘D-‘ on the same criteria, confidence in ESG assessments is eroded.

Nothing new

These ESG-related issues are not new. Long before the term ‘ESG’ was coined, companies focused on ‘social responsibility’.

In 1970, economist Milton Friedman argued against this by saying the primary responsibility of businesses is to maximise profits for their owners or shareholders. 
Friedman’s assertion, “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud,” still rings true, for many, more than half a century later.

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