WHEB Commentary

Seb Beloe

Just what is the point of ESG?

When I started my career working for an environmental consultancy in the late 1990s one of my first projects was to analyse the world’s entire library of corporate environmental reports. It didn’t take long – only about 100 reports were being produced at the time. Most of these provided a thin veneer of ‘greenwash’, though some, like the Body Shop’s ‘Values Report’ ran to several hundred pages and could only be purchased in hard copy!

Needless to say things have changed substantially since then.

KPMG’s 2013 analysis of company reporting counted more than 40,000 reports from 41 countries[i]. According to the research 91% of the UK’s largest companies produced a corporate responsibility, environmental or sustainability report in 2013. In the US the equivalent figure was 86%, in Japan it was 98% and even in Kazakhstan, 25% of the country’s largest companies produced a corporate responsibility or equivalent report. In some countries of course, producing such a report is mandated and so coverage is essentially universal among large companies (for example in France, Denmark and South Africa).

ESG Integration: the ‘cause célèbre’ of responsible investing

Back in the 1990s, the investment world was largely ignorant of the still nascent efforts by companies to report on their environmental and social impacts.  ‘ESG’ did not yet exist and in any case using it in investment would have been impossible with so few companies reporting on these issues, and even fewer providing any useful data.

Today of course, ethical investing, as defined by negative exclusionary screens has been overtaken by ‘ESG integration’ which has increasingly become the ‘cause célèbre’ for responsible investing. Nowhere is this clearer than in the evolution of the UN Principles for Responsible Investment (UN-PRI) where the ‘Integration of ESG’ is no less than the first of the six core principles.

In fact, after a cursory look at the UN-PRI, you would be forgiven for thinking that ESG integration is now a fully mainstream part of the investment agenda. The UN-PRI now counts its members in the thousands and their assets in the trillions (US$59 trillion at the last count). What’s more, the most recent assessment of signatories indicates that over 50% received either an ‘A’ or an ‘A+’ for the quality of their ESG integration[ii].

ESG is focused on process, but sustainability is also about product

In the push to establish ESG as a core part of investment decision-making, this seems to suggest strong grounds for optimism, if not outright celebration. Unfortunately, we should be rather less sanguine about these results.

The stated goal of the UN-PRI is to ‘understand the implications of sustainability for investors and support signatories to incorporate these issues into their investment decision making and ownership practices[iii]. ESG integration is certainly an important tool in understanding ‘the implications of sustainability for investors’. It is core to our own investment philosophy at WHEB Asset Management and helps us, we believe, to identify higher quality companies that are more likely to outperform peers who are less adept at managing these issues.

The problem is that ESG integration has become short-hand for sustainability as a whole. ESG analysis, as currently practiced by much of the market, focuses almost exclusively on internal policies and processes at a company and pays little attention to the environmental or social impact of the product. Ironically, this represents a complete volte-face from the ethical investing forerunners of the UN-PRI who looked at nothing but the product.

This approach leads to the absurd situation where Volkswagen can be considered a leader in sustainability – while its products are rightly demonised for their major negative environmental and health impact. The same should be said for coal, oil and gas companies as well as food and beverage companies whose product portfolios are laden with sugar and salt. Ultimately does it matter that a tobacco company’s cigarettes are fairly-traded or that a coal company has improved its internal energy efficiency? Perhaps – but not much – and demonstrably not more than the impact of their products on the health of people, communities and the environment.

Understanding product impacts

This is particularly true of industries where their main impact is in the use of the product (or indeed service). Between 60% and 98% of the environmental impact of a car is in its use (depending on fuel source and power train technology)[iv]. Volkswagen could literally run its entire operations on renewable energy, but this positive profile would be quickly reversed if its vehicles perform worse than their peers. It is therefore deeply ironic, that while some ESG analysts have stalwartly defended Volkswagen as an ESG leader, the rest of the market rapidly sold off Volkswagen stock because of their concerns over the environmental performance of their vehicles.

Such muddled thinking about what ESG means is leading to poor investment decisions, and misleading investors. There are now plenty of asset owners that are conflating ESG with an holistic assessment of a company’s overall sustainability. Products labelled ‘positive impact’ and ‘sustainable’ are populated with companies that have strong relative ESG performance but produce products that are directly responsible for some of the most significant environmental crises. Meanwhile businesses supplying the solutions are overlooked. Companies providing LED lighting systems, innovative high efficiency manufacturing equipment and solar power technologies are typically excluded on the basis that they have not published their green procurement policies.

ESG is just one ingredient and is not the full recipe

ESG is now firmly on the agenda for a very significant part of the investment community. This represents extraordinary progress in a relatively short period of time, but it is emphatically not the end of the story.

Ultimately, ESG integration is an important tool in understanding the implications of sustainability for investors, but it is just one of the tools. To paraphrase recent comments from one of WHEB’s advisory committee members[v], ‘ESG issues are just some of the ingredients, but understanding the total impact of a company should be the recipe’.


[i] https://www.kpmg.com/Global/en/IssuesAndInsights/ArticlesPublications/corporate-responsibility/Documents/corporate-responsibility-reporting-survey-2013-exec-summary.pdf

[ii] Pilot Assessment Report 2015, WHEB Group

[iii] http://www.unpri.org/about-pri/about-pri/

[iv] http://www.environment.ucla.edu/media/files/BatteryElectricVehicleLCA2012-rh-ptd.pdf

[v] https://www.whebgroup.com/media/2015/11/20151023-Summary-minutes-final.pdf

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