Excerpt from the ESG Handbook by Bruce Davis



Even for experienced investors, the world of ESG investing can be a minefield. In the new ESG Investing Handbook, editor Becky O’Connor brings together industry experts (including our own Bruce Davis) to cover the big questions and themes: ranging from the effectiveness of divestment versus engagement strategies for promoting positive change, as well as difficult topics, such as greenwash.

And, to get a flavour of what you can expect, you can read Bruce Davis’ chapter from the handbook below (or read on for a special offer if you want to download the eBook or get your hands on the hard copy).

What do you think of ESG?

The investment philosophy that underpins ESG has many parents, which makes it hard to generalise about its value alongside other schools of investment thought. At one extreme, it is about trying to change the way companies behave, to recognise that their licence to operate requires greater social and ethical responsibility on their part as ‘citizens’ of the economy. At another, it is simply an extension of the marketing 101 of investment management, namely that it is a route to some form of alpha which beats the market because its criteria reduce downside risk (specifically the risk of bad corporate actors or companies falling out of favour with society or the market).

The tipping point of environmental consciousness, crystalised by the declaration of a climate emergency, has further muddied the waters as it has swept away many of the detailed ethical concerns and criteria for the immediate and overwhelming need to decarbonise our economies. However, as the movement for a ‘just transition’ shows, green does not always mean good for society and there are many shades of green or climate investment which are open to criticism for being causative of wider social and economic issues (which themselves could be handbrakes on the transition) or out and out greenwash — prolonging the profitability and value of otherwise ‘stranded assets’.

In summary, ESG is not very useful as a category term, there is no such one thing as ‘ESG investing’, instead it is the start of an often complex and nuanced enquiry into the purpose of particular investment funds or companies and whether they live up to promises they make.

Are there examples of sectors or companies that combine all three?

All green investments should look to the three pillars of ESG to make sure their contribution towards fighting the climate emergency doesn’t come at a cost elsewhere in society. If this feels like a higher bar for green investments that is only because those who are still willing to invest in ‘non-ESG’ companies are willing to forgo values for profit. It is arguably the role of regulation to punish or constrain those companies who socialise the costs of their activities to maximise profits for their shareholders or owners.

Since 2020 we have seen more investments in ‘transition’ sectors (such as food production and transport), which have all had elements of the three pillars for investors to consider, but it is rarely a cut and dried equation — investors must weigh up the relative benefits and costs in terms of impact just as they consider the relative financial returns and risks involved.

How can we make ESG more demanding and more credible? is it through regulation and policy?

Very simple, regulation, regulation, regulation. Companies won’t create standards out of thin air and relying on markets to ‘discipline’ companies only works if all investors are signed up to the same standards and requirements, otherwise there will always be investors who look for alpha ‘wheat’ amongst the market ‘chaff’.

The issue for regulation is that it is still operating very much via a rear-view mirror. The early problems of ESG greenwash have been overtaken by a more complex set of issues for investors. Rather than past performance and reporting, scrutiny needs to be applied to the ‘forward statements’ of companies and funds and assessment made whether they are credible individually or collectively. If, for example, a company like Shell makes claims for future carbon neutrality whilst maintaining its presence in fossil fuel extraction, what impact does that have on the economy as a whole to decarbonise? Can an airport credibly make claims to be ‘carbon neutral’ at a future date when the transport it facilitates does not have a credible plan or technology to decarbonise within a meaningful timeframe for our carbon budget?

Ultimately therefore it will be government policy which forces companies to comply — or go bust — and the time we have before that particular approach is applied is fast arriving. In other words, the investment risk of maintaining an optimistic view of the ability of technology and innovation to solve our problems could well mean that soon ESG will be the only option for investors.

Does greenwash undermine the whole idea of sustainable investing?

The potential for greenwash is always present and requires constant vigilance. It doesn’t undermine the idea of sustainable investing, but it should make you cautious when funds or companies make claims about being sustainable in the absence of clear regulatory guidance or sanction on the issue.

Is ESG really just ethics by another name?

At its purest, ESG is an attempt to bring ethical considerations to business decisions and investments. In reality it falls somewhere between beliefs or values about building a better world and a philosophy of pragmatism or laissez faire utilitarianism.

When we talk about ethical investing we are talking about people who are conscious that their money is not a neutral actor in society, it has consequences and the investment of money carries greater responsibility than just the stewardship and conservation of individual wealth.

Money is the most powerful tool for collective action ever invented, but it has become subject to competing ethical beliefs about the value of money which mean that it is now divided between those who are altruistic about what their money can achieve for society as a whole, and those who believe that the invisible hand of self-interest is sufficient moral guidance.

ESG is an attempt to bring those altruistic values to bear on companies who otherwise would see themselves purely as stewards of capital rather than a body with a wider purpose and value to society. As with all ethical frameworks it is only as good as the means by which you can measure or assess the impact of ‘purpose’ often in the absence of a counterfactual.

How can investors tell if something is truly sustainable?

There are increasingly better metrics to assess the sustainability of an investment in terms of climate or another measure (such as those within the Sustainable Development Goals). However, no single investment will provide a magic bullet of sustainability, but investors instead should look at their portfolio as a whole and try to make sure their money is on the right side of history when it comes to the reckoning on existential issues such as the climate emergency or chronic inequality.

What does good/bad ESG look like?

Bad ESG is about prolonging the value of assets which would otherwise be either stranded or worthless (or illegal), good ESG is about building a better world that doesn’t simply bake in the problems of the past inside a green-tinged wrapper.