With the noise and interest in ESG investing reaching levels that would have been unthinkable a few short years ago, much of the analysis surrounding it is becoming polarised. A more sophisticated conversation and debate is required, argues Mark Versey.

What’s not black and white, but grey all over? Answer: ESG investing.

This might seem a strange assertion for a responsible investing advocate to make. Surely, I should be extolling the unbridled virtues of the discipline, particularly in the wake of recent high-profile criticisms of it? To do so would be disingenuous, however. Let me explain.

Part of the reason Tariq Fancy’s1 brutal, but to my mind overly simplistic, critique of responsible investing gained so much attention was that elements of what he said are true. The other, more worrying, reason is that we have completely lost our collective sense of nuance. Instead, we seem to crave crude answers to complex problems: ESG is either good or bad; finance equally so. Such a lack of sophistication in reasoning has serious implications.

A series of examples reveal the contradictions and inconsistencies that a simple – un-nuanced – ESG lens finds hard to reconcile.

When E and S collide

Let’s take the recent strong performance of ESG investments. Firstly, while it is true that many responsible investment strategies have outperformed their broader benchmarks, this is largely confined to renewable and environmentally tilted stocks. Where it has applied to broader portfolios, large weightings towards tech companies tend to be found.

A greater tax contribution could be used to fund socially useful areas

It is here where environmental factors start to collide with social ones, which are notoriously hard to define and measure. For example, tech companies pay little tax, particularly in jurisdictions where their activities have a large impact. As a recent Financial Times article pointed out, a greater contribution to government coffers could be used to fund socially useful areas like education, healthcare, social care, and other critical public goods.2 Big Tech has also come under heavy criticism for its role in undermining democracy, amplifying hate speech and exacerbating mental health issues.

Of course, the opposite can also be argued – think of the Arab Spring and increased connectivity and social connection globally. As I said, things are rarely black and white.

There is an alarming disconnect between actions on climate and human rights issues

To further illustrate the point, the World Benchmarking Alliance recently published a performance update on its Automotive Benchmark, which tracks the progress of 30 of the biggest companies in the sector in meeting the goals of the Paris Agreement. When they compared it with the Corporate Human Rights Benchmark, it revealed “almost no correlation could be found between a company’s relative performance on either benchmark, suggesting an alarming disconnect between actions on climate and human rights issues”.3

It is no wonder that benchmark and rating confusion exists: depending on the relative weightings providers apply to certain factors, the results will be different. A recent comparison of MSCI and ISS ESG datasets for companies’ controversy scores found only 11 companies overlapped.

Figure 1: Overlap between MSCI and ISS controversy scores
Overlap between MSCI and ISS controversy scores
Source: MSCI, ISS, Aviva Investors, as of March 8, 2021

The authors of a paper entitled Aggregate Confusion: The Divergence of ESG Ratings4 argue that to help rectify matters, “companies should work with rating agencies to establish open and transparent disclosure standards and ensure that the data is publicly accessible”.

Voice and exit

Then you have the issue of divestment.

Understandably, many people do not want to hold ‘dirty’ assets like fossil-fuel companies or high carbon-emitting buildings on ethical grounds. However, even this seemingly clear-cut moral decision is not straightforward. Firstly, it assumes you can solve a demand issue simply by cutting supply. I wonder how many of the same people who balk at the idea of holding a fossil-fuel company, or so-called brown stocks, have also tried to eradicate their own demand for polluting products?

Divesting equates to losing your voice

I understand the power of signalling, but there is also the question of voice and exit, as economist Albert Hirschman highlighted. Divesting equates to losing your voice. If you stay invested in a company and continue to wield the credible threat of divestment while speaking up on key resolutions at shareholder meetings, you will arguably make more of a difference than if you simply walk away. You do have to be prepared to walk away if your demands and expectations for change are not, though – recognising when an engagement programme has failed. Otherwise, your threat will be hollow.

Furthermore, are all energy stocks equally bad? Could some of them not be transformed into major players within the green energy revolution? Of course, there are challenges to this line of thought, such as siloed thinking and operations, bureaucracy, domain-specific expertise, joint-venture structures and pressure to pay out dividends (which provide income for investors and retirees, by the way). But it is interesting to note that, in the US at least, energy firms are key innovators, producing more and significantly higher-quality green patents than other industries.5

Renewable waste

A supposedly more impact-driven way of clearing your conscience is simply to invest in clean technologies and renewable energy. Or is it?

Electric batteries rely on mining cobalt, lithium and nickel, among other rare-earth materials. Supply chain and human rights issues abound, with China controlling significant amounts of these crucial mineral supply chains. Furthermore, the mining of lithium in Chile has prompted legal fights over water in the Atacama and 70 per cent of cobalt is mined in the Democratic Republic of Congo, a country with an extremely bad track record when it comes to corruption and labour standards.6

There is also the issue of waste which the renewable sector has yet to face up to

With demand for these minerals set to soar, such issues are unlikely to go away. There is also the issue of waste which, being a relatively nascent industry, the renewable sector has yet to face up to. Wind turbines, solar panels and electric batteries all must be disposed of or recycled somehow – with the latter two containing particularly toxic metals like lead and cadmium. In the case of the former, the US will reportedly have more than 720,000 tonnes of wind turbine blades to dispose of over the next 20 years.7

Until it costs less to extract these elements from renewable wastage than to dump them in landfill and mine fresh raw materials from the ground, we will still have an issue. While I have confidence that the circular economy will be mobilised to tackle these issues, the current state of play proves again the need for nuanced thinking.

A ‘just’ transition

Next is the notion of a ‘just’ transition. While the hope is many developing nations can simply ‘leapfrog’ dirtier forms of energy as their economies and societies develop, is it really fair for developed nations to preach to developing countries about the moral and scientific dangers in using fossil-fuel-based economic expansion? The hypocrisy is clear: we have already ridden that wave, extracted (most of) the progress (and resources) required, only to have seen the light and turned over a new – greener – leaf.

Some countries will need to rely on ‘brown energy bridges’ for some time

This is why we recently helped fund an oil refinery in the Ivory Coast. It is also why we acknowledge some countries have deeper social issues and will need to rely on ‘brown energy bridges’ for some time. Only when you have food in your belly, a roof over your head and a feeling of security can you start to consider wider societal and environmental issues. 

In reality, ESG cannot be reduced to simple binary arguments. It encompasses such a wide array of meanings and activities that to try and do so is foolhardy.

Macro stewardship

For those of you still wondering which parts of Mr Fancy’s critique are true, it is his call for greater government and policy intervention. In investing terms, this equates to what we call ‘macro stewardship’ – which is another way of saying ‘market reform’. But by anchoring it in the language of stewardship, our wish is to tether it more closely to the core principles of ESG investing.

Market failures cannot be solved by micro-level nudges alone

Threats – or rather market failures – like inequality, climate change and environmental degradation cannot be solved by micro-level nudges alone (which, though worthy endeavours, impact investing and screening amount to). And while full ESG integration and engagement go a step further, they still fall short. As stewards of other people’s money and given the growing number of net-zero commitments, we have a fiduciary duty of care to do more: to use our knowledge, influence and our clients’ voice to push for systems-level change.

Navigating this ethical minefield in simple client fact-finding exercises, as laid out in the MiFID directive, is a start. Legal and industry standard definitions, alongside regulatory efforts like the EU’s Green and Social taxonomies and the Sustainable Finance Disclosure Regulation, are also welcome. But as the level of comfort and sophistication grows, far more will be necessary to truly capture clients’ preferences.

Trust and faith in investment brands will be crucial in dealing with ESG in all its nuanced glory

Language can be frustratingly malleable. Completely harmonising meanings in the minds of investors is desirable, but simply not possible. And while we must continue to better define the ESG landscape, it does mean that trust and faith in investment brands will be crucial in dealing with ESG in all its nuanced glory.

The truth is that it is extremely hard to neatly package up morals and then sell them on coherently and transparently. Mr Fancy, of all people, should know this.

Would you like to read the whole of AIQ: Cleaning up capitalism?

Subscribe to download a PDF copy or get a printed edition delivered directly to you.

Thank you for requesting a copy of our latest AIQ. We will send this to you shortly.

To keep up-to-date with our latest insights, please visit our main views page.

Please enable javascript in your browser in order to see this content.

Please select the format you wish to receive.

If you wish to receive a printed copy of AIQ, please enter your full postal address below.

I acknowledge that I qualify as a professional client or institutional/qualified investor. By submitting these details, I confirm that I would like to receive a digital and/or printed copy of the latest AIQ and receive thought leadership email updates from Aviva Investors, in addition to any other email subscription I may have with Aviva Investors. You can unsubscribe or tailor your email preferences at any time.

For more information, please visit our Privacy Policy.

View full edition online

AIQ: Cleaning Up Capitalism

To tackle the climate crisis, economies and markets need a systems reboot. In AIQ: Cleaning Up Capitalism, we examine what it will take to get us back on track to achieve net zero; from transforming the financial system and accounting, to decarbonising heavy industries and ensuring polluters pay.

Find out more
AIQ: Cleaning up capitalism

Important information

Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

In Europe this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK Issued by Aviva Investors Global Services Limited. Registered in England No. 1151805.  Registered Office: St Helens, 1 Undershaft, London EC3P 3DQ.  Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material.  AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 1Raffles Quay, #27-13 South Tower, Singapore 048583. In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business Address: Level 30, Collins Place, 35 Collins Street, Melbourne, Vic 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom. Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is registered with the Ontario Securities Commission (“OSC”) as a Portfolio Manager, an Exempt Market Dealer, and a Commodity Trading Manager. Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”).  AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.

Related views