Like many others, the COVID-19 lock-downs were an opportunity to develop new hobbies. One of my new hobbies was to join a film club. A few months ago, we watched ‘The Graduate’ starring a young Dustin Hoffman as the eponymous graduate ‘Benjamin’. A key moment in the film involves a friend of Benjamin’s parents advising him to get into plastics because “there’s going to be a great future in plastics.”
And of course, in the 1960s, when the film was set, getting into plastics would have been great advice. The success of that industry has brought plenty of benefits, but too much plastic has also of course created lots of problems that we are living with now.
If you are talking to a graduate today, I think the advice might be to get into sustainability or even into ‘ESG’.[i] Certainly, that seems to be the ambition of a lot of young analysts today. But might we be storing up future trouble by embracing ESG too unquestioningly?
Like selling wheatgrass to a cancer patient
Tariq Fancy certainly thinks so. Mr Fancy is the ex-Chief Sustainable Investment Officer at BlackRock. He doesn’t just think that ESG is ineffective as other critiques have asserted.[ii] In a 40-page essay he claims that ESG is actively dangerous.[iii] After leaving BlackRock in 2019, he concluded that ‘our work in sustainable investing was like selling wheatgrass to a cancer patient’. Not only ineffective, but actively damaging because it delays the patient from receiving effective therapies.
Juxtaposed with this view is the argument set out in Sir Ronald Cohen’s book ‘Impact – Reshaping capitalism to drive real change’.[iv] This sets out a manifesto for a new way of thinking about finance, putting positive impact at its heart. The book argues that finance can have an enormously positive impact in addressing the critical challenges facing the world today. So who is right?
ESG focuses on reducing investment risk
The first thing to say of course is that ESG and impact investing are not the same. Fancy characterizes ESG as being like ‘good sportsmanship’. For Blackrock perhaps ESG is about trying to get companies to be better corporate citizens. But for most of the market, ESG investing is mainly about managing risk. Recognising that the world is changing, investors analyse exposure to material ESG issues, and assess how well-equipped companies are to mitigate these risks.
ESG investing processes may indeed help to avoid risk (we think they can) but this is not the same as reducing impact in the real world. Divesting a portfolio of carbon stocks is a good way to decarbonize a portfolio, but this divestment does little to decarbonize the economy.[v] Fancy is wrong to characterize ESG investing as nothing more than making ‘vague promises to be responsible’. But he is right to call out asset managers who claim ESG investing alone can save the world.
Impact investing focuses on creating positive impact
Impact investing in contrast is explicitly about creating positive impact in the real world. It puts impact at the heart of the investment case and seeks to measure the positive impact in the real world. ESG is concerned about real world impacts on companies. Impact investing is focused on a company’s impact on the real world.
Is there a business case for ESG?
Fancy also takes issue with claims that there is a financial case for addressing ESG issues (what he calls ‘the overlap between purpose and profit’). Improvements in ‘operational’ ESG – reducing energy use, hazardous waste generation, health and safety incidents – can deliver improvements in financial performance.[vi] However, we’d agree that it is an altogether greater challenge to claim a business case when the core product is under-attack. We have seen oil and gas companies improve their health and safety track record over recent decades.[vii] It has been much more difficult to get them to give up on their core product.
Impact investors, in contrast, invest in companies that sell products and services that help to reduce carbon emissions and create positive impacts. These are businesses that are enabling a transition to a zero carbon and more sustainable economy. And by enabling this transition, they also benefit from it because they sell more of their products and services. In these cases, revenue growth goes hand-in-hand with more positive impact.
How exactly companies and their investors create positive impact is beyond the scope of this blog but is something that we will be addressing in greater depth in a forthcoming white paper.[viii]
Like anyone confronted with the reality of climate change, Fancy believes that society needs to respond systemically and change the entire economy’s relationship with carbon. We wholeheartedly agree. In fact, 456 investors representing $41 trillion in assets also agree. This group, which included WHEB, signed a ‘Global Investor Statement to Governments on the Climate Crisis’ calling for urgent regulatory action to tackle climate change.[ix]
For these investors, ESG is not intended to delay regulatory change. Far from it. They are advocating for regulatory change and believe it necessary and urgent. This advocacy isn’t an alternative to ESG investing, but a complement to it.
BlackRock was not a signatory to this letter. In fact, Larry Fink asserted earlier this year that climate change should be addressed through self-regulation alone.[x] Some investors may be using ESG as a smokescreen aimed at delaying regulation. Tariq Fancy’s critique should be aimed directly at them.
[i] ‘ESG’ stands for environmental, social and governance and is short-hand for an approach to investing that takes account of these issues.
[ii] See for example Robert Armstrong, ‘The fallacy of ESG investing’, 23 October 2020, The Financial Times (https://www.ft.com/content/9e3e1d8b-bf9f-4d8c-baee-0b25c3113319)
[iii] Tariq Fancy, ‘The Secret Diary of a ‘Sustainable Investor’’, August 2021 (https://medium.com/@sosofancy/the-secret-diary-of-a-sustainable-investor-part-1-70b6987fa139 )
[iv] Sir Ronald Cohen, ‘Impact: Reshaping Capitalism to Drive Real Change’, 2020, Ebury Press
[v] We argue that divestment can have important socio-political ramifications but recognise that divestment itself will have little immediate effect on carbon emissions. For more on this point see Maximillian Horster, ‘Failed Theories of Change: Misperceptions About ESG Investment and Investment Efforts to Combat Climate Change’, in K. Wendt (ed.) Theories of Change, 2021, Sustainable Finance
[viii] We also briefly addressed these points in our 2020 Impact report available at https://impact.whebgroup.com/media/2021/06/WHEB-Impact-Report-2020.pdf