ESG has become a highly controversial topic, and we wanted to help dispel some of the myths and beliefs around what ‘ESG’ is and is not. ESG means using environmental, social and governance data alongside traditional financial research in analysis and security selection. There are a variety of distinct and sometimes overlapping reasons to use ESG data, from the pursuit of long-term outperformance, to aligning one’s investments with one’s values, to trying to influence positive social, environmental and governance change, to a combination of the above. The myths and confusion around the topic stem from disinformation, biases associated with traditional financial beliefs, and a general lack of understanding. Here are 5 myths about ESG and our thoughts on the reality behind the myths.
Myth #5: ESG is political
Reality: Parts of the ESG space certainly get politically heated. However, people all over the political spectrum want workers to be safe, want less toxic waste dumped in waterways, and want companies to operate ethically and not to commit fraud. At its core, ESG is about good business operations, not political beliefs. Check out our piece on the topic: Is ESG political?
Myth #4: Large companies can’t solve the world’s problems - only government and non-profits can.
Reality: Everything that happens on this planet creates negative and positive externalities that impact societies. Governments play a role in regulation and funding, as does philanthropy and non-profit activity. However corporations, especially large ones, make an outsized impact on those positive and negative outcomes. Corporations also influence governments and non-profits through lobbying, lawsuits, and donations etc. We need all stakeholders to work together to drive sustainable systems change. Check out our piece on the topic: Net positive impact
Myth #3: ESG is all about divesting from fossil fuels.
Reality: Many ESG strategies do not divest from fossil fuels, or only divest from specific types of fossil fuel production. Many active strategies focus on investing in energy companies that are leading the energy transition and/or choose an engagement strategy to push for change within energy companies. In the case of index products, energy companies are often still included but strategies might reduce weights as compared to the index. Even strategies like Honeytree’s, which do not invest directly in coal, oil or gas producers, have huge exposure to fossil fuel. Whether fuel, plastic, gas or other petroleum products, all companies have some exposure to fossil fuel. Check out our piece on the topic: Can a portfolio really be fossil fuel free?
Myth #2: ESG is a constraint that reduces performance.
Reality: In investing we put many constraints on the portfolios we build with such things as factors, size, sector and geographic exposure, etc. When ESG data is used in security selection it imposes a similar type of constraint. Limiting exposure to companies with high employee turnover, health and safety infractions or accidents, or high fuel costs are examples of ESG constraints, which, if balanced appropriately with traditional financial data, can add to a deeper understanding of management and the potential to grow the bottom line. Check out our piece on the topic: Putting non-financials on equal footing
Myth #1: ESG is all about ratings
Reality: An ESG rating is much like a buy/sell rating, serving as external research that investment teams might incorporate into their security analysis. However, just as many financially-focused portfolio managers primarily use their own research in security selection, many ESG-focused portfolio managers prefer their own internal ESG research to externally sourced ratings. To simplify ESG down to ‘ratings’ overlooks how numerous corporations view ESG-related issues as intrinsic to their finance and operations, rather than as a separate set of criteria to be evaluated in isolation. Check out our piece on the topic: Look beyond ESG ratings
As investors grow more informed about ESG, outdated critiques of responsible investing will fade. Educating investors about these misconceptions is crucial to advancing responsible investing over the long term.