Environmental, social and governance (ESG) is now big business. What began as a niche market decades ago has blossomed into a multi-trillion-pound industry and continues to grow at an alarmingly fast rate. According to the specialist research provider Eiris, more than £15bn was invested in UK ethical/socially responsible retail funds in 2015, up by 11% year on year.
But as with all growing markets, there have been red flags. In September, BlackRock and Vanguard were accused of hypocrisy when they voted against a resolution to force ExxonMobil to assess climate risk to its business, by dint of the fact that they were signatories to the UN’s Principles of Responsible Investment.
These charges of hypocrisy highlight a huge disconnect between ESG the ‘buzzword’ and ethical investing in practice.
The conflation of terms such as socially responsible investment (SRI) and ESG further reinforces the idea that fund managers and investors are not speaking the same language when it comes to ethical investing.
Shades of green
Courtiers Asset Management’s head of fund and asset management Caroline Shaw says, beyond fuzzy definitions, ethical and responsible investing covers a continuum of ‘shades of green’. It is similar to a model proposed by US writer and environmental activist Alex Steffen, who divides contemporary environmentalists into three categories:
l light green – who view protecting the environment as a personal responsibility;
l bright green – who say technological and regulatory changes are required to affect sustainability; and
l dark green – those who contend environmental problems are part of industrialised civilisation and to eliminate them demands a radical overhaul of consumer culture, among other facets of modern day existence.
While Shaw’s spectrum of ethical investing is far from an exact corollary of Steffen’s breakdown, the gradation of attitudes toward environmental and social responsibility is similar.
Shaw classifies ESG as being on the light-green end of the spectrum, whereas a more negative exclusionary screening investment process sits at the dark end of the scale.
She says: “I have always seen ethical investing as a scale of shades of green with dark green being the strictest exclusionary end of the scale, where you exclude companies that are involved in ethically questionable industries such as armaments, pornography, alcohol and gambling.
“Recently, we have even been looking at ethical funds that exclude companies that make political donations.”
By contrast, Shaw believes that ESG investing fits within the light-green bucket, which takes ethical considerations into account when selecting stocks but uses a flexible ethical mandate as a guiding tool for investments.
“Fund managers who invest along ESG lines employ more of a soft touch. They are trying to do the right thing by excluding some companies but they might not mind having a stock in their portfolio that has ties to pornography as long as the company only derives 10% of its total revenue from it.
“Another fund manager might be happy to invest in a company that has some issues on the human rights front, as long as the company is working towards resolving them.”
Because ESG permits more ethically grey areas, it is easy to understand why it “has become the more acceptable face of ethical investing, or certainly the more popular face”, says Shaw.
It is also more attractive to fund managers because they have a wider universe of stocks to choose from and, consequentially, a bigger audience to market to.
She says: “If you can put yourself at the light-green end of the ethical spectrum and brand yourself as ESG, you have got something that is ‘feel good’ but also has a wider universe of stocks and is a lot more flexible.
“I think that would be ringing a lot more bells, in a positive sense, with all the fund management groups out there and it is certainly easier to market.”
