Stop the ESG Nonsense

Investment funds labeled “sustainable” or “ESG” for environment, social, and governance have enjoyed a rush of inflows in the last few years. ESG investing, depending on how you measure it, accounts for one-third of total U.S. assets under management. But recently there has been a backlash. Some of this backlash is on target; some of it is completely wrong.

None of it, however, fully identifies the worst thing about the ESG industry.

What is ESG investing?

ESG or sustainable investing involves evaluating the environmental, social, and governance performance of firms in which a fund is invested. Usually, an asset manager engages an outside research firm such as Thomson-Reuters, MSCI, or Sustainalytics to assign ESG ratings to companies being considered for its funds. The aim is for the fund (or ETF) to achieve a high average ESG rating.

Environmental performance is judged by a firm’s greenhouse gas (“carbon”) emissions or plans to reduce them, and other environmental benchmarks. Social performance is judged in part by the firm’s “inclusiveness” and racial, ethnic, and gender diversity. Governance is judged by the independence of its board, ratio of executive pay to average employee pay, and other such factors.

The sustainable investing surge

Sustainable investing has had an incredible run over the past several years. The exhibit below, from Morningstar, shows the extent of its growth.

Assets in funds holding themselves out to be sustainable or ESG investments have increased by a factor of four in the last decade. Inflows into ESG funds in 2020 were more than double the previous year, and 10 times those in 2018.