ESG is a dead man's party for investors, but...

it should be brought back by companies

It might be time for the financial markets to let go of ESG. Even in assessing what has transpired over the past few years regarding ESG’s rise and decline, there is still much confusion between saving the world and saving the company through long-term analysis.

Is ESG dead? Well, of course not. Just because the markets are moving to other terms like ‘sustainability’ and getting more specific with ‘energy transition’ doesn’t mean that climate risk or stakeholder issues go away for companies.

Still, companies can breathe a little in the refocus and figure out what ESG means for them.

In the meantime, the Financial Times framed this question of ESG’s death differently. It isn’t who killed ESG because it isn’t dead, but who killed the ESG party? Oh, and ESG was absolutely having a party with investors from 2020 through 2022. There were tons of inflows into funds and fees to go along with it, but the marketing hype and financial products associated with ESG have declined since.

In asking the question about the death of ‘the ESG party,’ several suspects emerge.

It’s time to open up our box of Clue and deal you in. If you aren’t familiar with the Parker Brothers classic board game, it involves Mr. Boddy, who has been murdered by one in a group of suspicious characters. You need to figure out the murderer, the location, and the weapon used before the other players do. Clue is also a fantastic comedy from 1985 that is well worth the watch.

Let’s review the suspects in the Financial Times documentary and see what we can find.

The Suspects

Vladimir Putin (Colonel Mustard) in Ukraine with the army
The first suspect is Russia’s invasion of Ukraine and increasingly rising global tensions. This has caused investors and companies to buckle down and refocus on fundamentals. This is a pretty good guess, but it has one problem. Geopolitical risk is ESG. Understanding your company’s intersection with geopolitical tensions is a Governance move, and backing away from non-material environmental and social justice issues, while disappointing, might open up the door to addressing more material matters.

If anything, Russia’s invasion of Ukraine should have refocused companies on material ESG issues that they should’ve been focused on anyway. This might be how companies appear to be ‘getting ESG right’ against the deafening silence of greenhushing.

Tucker Carlson (Mr. Green) on Fox News with the microphone
The interviewees focus specifically on Tucker Carlson as the West’s leader of the anti-ESG movement. In 2022, Carlson blamed ESG for the collapse of Sri Lanka, which I covered in the fourth issue of The ESG Advocate. Yet, if you search YouTube (DO NOT DO THIS), Glenn Beck talked about this years before Carlson. Regardless, the conservative movement has indeed played a role in shutting down the ESG party.

However, despite the pullout of sustainability funds, as Katie Marin, Markets Columnist at the FT, points out, there aren’t states where you shouldn’t talk about ESG unless you are talking to politicians. Having spoken with companies across red and blue states, ESG and sustainability topics are still very much front of mind despite the political machinations.

You can hear this in Nicolai Tangen’s comments. Tangen is the CEO of Norges Bank Investment Management. He states that while the pullback is disappointing, the bank hasn’t changed its engagement approach with companies. A board and management team would do well to at least pay attention to this issue, as it isn’t only investors who are bringing the heat.

Last week, CFO magazine reported that over 90% of 700 finance chiefs polled by Accenture “agreed that ESG issues will be a major focus for them over the next five years.”

Asset Managers (Mrs. Peacock\Miss Scarlett) on the trading floor with the funds
In ESG Mindset, I assign some blame to asset managers for the confusion surrounding ESG. They were overeager to capture investor sentiment and quickly attempted to extract value from values.

You are not a suspect if you work at an investment firm and clearly defined ESG against other investment strategies. If you don’t clearly define ESG, you might want to get on that soon.

Over the years and in reflection, I almost feel bad listening to Tariq Fancy, former CIO of Sustainable Investing at BlackRock. Fancy has been an outspoken advocate against ESG for its assumption of a free market correction to global issues. Hearing him talk reminds me of what I hear every day. Due to disclosure pressure, I struggle to find corporate sustainability folks doing meaningful work. I get the sense from Fancy that ESG didn’t afford him meaningful work similarly. Why? Real ESG leads to material issues and does not save the world, at least not directly.

If you put someone who wants to save the world in charge of an ESG strategy, they may struggle to see the impact a company can have by managing the effect of the world on a company. After all, it isn’t easy.

He misstates ESG’s thesis as “society improving because companies discover social purpose.” This isn’t what ESG is but what the markets have turned it into. What’s fascinating to me is just how much of a foil he has become to the argument that asset managers did sow the confusion in the first place.

Henry Fernandez, CEO of MSCI, nails an often-overlooked point: investors aren’t a single type of stakeholder. A hedge fund might only care about the short-term, whereas a pension will care about the long-term. Only the pension fund will likely care about ESG. I find it unsurprising that the CEO of the largest ESG data aggregator understands this nuance. To take his example further, some investors want to invest their values, and most want returns. This is where the idea of a win-win was created, but it simply doesn’t exist.

Desiree Fixler (Mrs. White) at DWS with the whistle
Desiree Fixler was the whistleblower who gained fame by correctly calling out her employer, DWS, for greenwashing and misrepresenting the work that they were doing in this space. In 2022, German authorities raided DWS and Deutsche Bank over these greenwashing claims.

Further, Desiree Fixler makes a good point in a hypothetical where an asset manager could cost an investor 2-3% by applying an ESG lens to an investment. Yet, this, too, is inaccurate as it subscribes to the definition that some asset managers seem to prefer of a values-based investment. An ESG investment should effectively manage risks and consider opportunities, which would be no different than any other material and fiduciary issue.

We saw this with Hester Pierce’s Climate Rule dissension in March of 2024:

Our existing disclosure regime already requires companies to inform investors about material risks and trends—including those related to climate—by empowering companies to tell their unique story to investors.

In other words, if an issue is material, it should already be disclosed. Just like if an issue is material, an investor should already be factoring material issues in, and there are MANY material ESG issues for every company to factor in.

ESG Ratings (Professor Plum) on Wall Street with the scores
There is a lot of confusion about ESG ratings because they vary. Again, Henry Fernandez explains that ESG scores are opinions on how “these variables will impact the financials of the company.” Fabiana Fedeli, CIO of Equities and Sustainability at M&G Investments, calls out the variation of ratings (and I happen to agree) as a benefit. Differing opinions examined by analysts can uncover differentiated value.

When I talk to companies about ESG ratings, I often hear echoes of sighs and displeasure with this firm or that firm. I rarely find a company that uses ESG ratings and analysis in the way that investors do (this is why I picked Professor Plum here).

Here are some quick recommendations. First, work with your Investor Relations team to discuss your score with the rating agency to understand how the opinion was formed. If given the chance, inform them of your view and the work you have done. If you can’t connect with them, read your CSR/ESG reports and see if you can reverse engineer how they came to the opinion they have. I regularly review these ratings and can typically figure out how and why the scores are what they are, at least within reason.

The real culprit is…

ESG’s multiple definitions (Wadsworth)
Yes, the real culprit is the dueling definitions of ESG that allow all of the above to take hold. The shifting definitions of ESG between the world's effect on the company and the company's impact on the world open up the risk of killing the ESG party through ambitious opportunities laid bare by each of these individual suspects.

As a side note, towards the end of writing “ESG Mindset,” I realized that I had been using the term ‘impact’ to describe both of these directions (impact out and in). I added the term ‘effect’ as in the previous paragraph to differentiate the definition.

There are multiple endings of the original “Clue” movie, but the one relevant here is where everyone kills someone. Of course, none of them would have been a culprit if not for the original orchestrator of the evening, Wadsworth, the butler, played by the incredible Tim Curry.

During the documentary Desiree Fixler calls ESG “an umbrella term that means different things to different people.” You can hear this from Katie Martin, a Markets Columnist at the Financial Times with words like ‘green’ and ‘virtue.’ If you listen to Tangen and Fernandez, you will hear something different.

And so, ESG has come to mean values and value. It can cover a risk management perspective, going through a transition, or represent the company’s impact on the world. In last week’s Bloomberg article Wall Street Starts Calling Time on ESG Labels After Backlash, Saijel Kishan writes just how imprecisely the term has been used. This is the core problem of ESG and why I wrote “ESG Mindset.” ESG does mean something specific for companies and should mean something different than ‘sustainability’ for investors, which appears to be the latest trend.

I open the book with a relevant stark sentence:

This book will not save the world.

Why? Well, because ESG won’t save the world, it will save the company.

The documentary ends with whether or not ESG is going away, with the future articulated as confusing as the present. There are comments that it will just be incorporated into investment strategies (it likely will be how Pierce outlined it in her dissent). The term may go away, or it won’t go away, or we don’t have a choice because of the necessary and specific transition away from fossil fuels and the looming threat of climate change. The last point here around transition has shifted since Larry Fink’s latest letter to investors calls the energy transition a key investment opportunity. Let’s not forget the misguided article in The Economist stating that E should mean emissions.

So, again, maybe some financial services firms should just let ESG go, at least for a while.

At the train station of ESG choices and definitions, departing trains will take companies down unproductive rabbit holes when they would be wise to focus on the train of materiality, stakeholders, and the long-term. Companies must take this train and ignore the others to plan for the coming seismic shifts effectively.

In addition to a consistent definition of ESG in the financial markets (and at least one consistent path forward), companies, not financial market players, can rescue ESG, and they should. Taking ownership of the acronym and executing according to their core business as a starting point shows investors and other stakeholders that the board and management team understand their business and can manage complex and complicated issues.

I wrote about some optimistic progress three weeks ago as Dell, Lenovo, and The Carlyle Group all unapologetically used ESG in their report titles and throughout and used it correctly!

And so, if I have a role to play in all of this, I suppose it would be the underappreciated role of The Chief (played by Howard Hesseman) at the end of Clue, who first warns the culprits and then later bursts in with his police squad to make the arrests and ironically ends the party:

“Have you ever given any thought to a consistent definition of ESG? Repent! Risks and opportunities are at hand! Your companies are in danger!”

While I have no power to hold any company directly accountable, investors should do so through proxy voting, and this, along with engagement, as Tangen suggests, is their new role. It is time to pass ownership of ESG to those executing and moving the markets into a supporting role as providers of capital.

What a strange and novel idea!

In the meantime, I will keep advocating for ESG to make sure companies are protecting their businesses long enough to be around to save the world if they choose.

And just as The Chief goes uncredited in the movie, I expect I will as well.