ESG morphs into glorified box-ticking exercise

Impact investing is being touted as an alternative to environmental, social and governance (ESG) strategies failing to live up to their ethical hype.

While confusion reigns in ethical investing over terminology, 7IM distinguishes ESG as focused on a company’s operations, whereas impact investing focuses on their goods and services, making sure they make a positive contribution to society and the environment.

A recent study by Royal London Asset Management recently revealed that two thirds of professional investors expect to allocate more money to ESG strategies in the next three years. And ESG has become increasingly incorporated into asset manager’s investment strategies.

Glorified box-ticking exercise

However, Gary Waite, portfolio manager at Walker Crips, is sceptical that an ESG approach is meeting ethical investors’ expectations.

“Very much like conducting analysis on financial statements, ESG data can be manipulated and made to look far more significant than it actually is,” Waite says.

“At the most basic level it can be a glorified box-ticking exercise designed to promote an ideal to a broad array of investors – or fulfil certain key performance indicators of a company’s management –  rather than a true reflection of reality.”

For investors, Waite says due diligence is essential to separate companies where ESG is a driving force in corporate culture versus those just paying lip-service.

Amanda Tovey, investment manager at Whitechurch Securities, says larger corporates have more money and resources to put into generating sustainability reports and publicising sustainability strategies, making it readily available for the use data providers.

“This can mean that large corporates score better than a much smaller company who may well have a much better sustainability strategy but less resource to publicise it,” Tovey adds.

Asset managers need resource and commitment to do ESG properly, according to Tilney managing director Jason Hollands.

“For some asset managers, this can end up as a mere box ticking exercise with little evidence of genuine engagement with company management, perhaps relying too heavily instead on voting their stock in accordance with the recommendations of corporate governance agencies,” Hollands says.

Impact investing vs ESG

Tim Crockford, manager of the Hermes Impact Opportunities fund, argues that with impact investing, it’s harder to hide behind the data because the positive impact the company is having is “very obvious to the man on the street”.

“With ESG, it’s very easy to get into this spiral of focusing only on data and data tagging things and therefore, when you focus only on data – with the right data sets you can make anything look like what you want it to look like,” Crockford says.

ESG funds can include exposure to sectors that many ethical investors would not be comfortable with, such as tobacco or oil.

Architas’ investment director Adrian Lowcock says: “ESG is much broader and more complex it looks more closely at the journey of all companies not just those with a good social agenda.

“For me impact investing is more about the traditional ethical investing approach – avoiding companies that have a negative social impact such as tobacco or weapons, although with the added focus on supporting companies with a positive social agenda as opposed to just avoiding those with the bad.”

However, impact investing is yet to establish universal standards for measuring positive externalities, says Hortense Bioy (pictured), head of passive strategies and sustainability research at Morningstar.

“Impact investing may be seen as an opaque segment of the sustainable investing space because of the challenge of measuring impact. There is no standards, which makes it difficult for investors to evaluate and compare offerings,” Bioy says.

Room for improvement

Despite concerns around ESG, each data and research provider has its own methodology and they may look at different indicators and use different data sources, which naturally may lead to different conclusions and ratings.

Lowcock says while the data being open to manipulation is true, “it has always been an issue in business – so much is open to interpretation and the risk of abuse.”

“However it doesn’t mean we shouldn’t try to improve things and record the results, learn from them and improve,” he adds.

“Data is open to interpretation but so is the social and ethical perspective, social media for years was seen as a force for good but the recent issues with Facebook and Cambridge analytic has forced investors to reassess their views and values.”

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