As many hop onto the trend of ESG investing, contrarian views have appeared more recently. Professor Aswath Damodaran’s perspective on ESG in his article: ‘Sounding good or Doing good? A Skeptical Look at ESG’ is particularly provocative.
While Professor Damodaran has pointed out that one major issue with ESG is the unverified, opaque and seemingly incompatible measurement framework, others claim that the only victors of ESG are the companies that exploit ESG and use the acronym to attract resources while doing little in guaranteeing ESG standards.
The issue with impact-washing is that it is intrinsically linked to ESG measurement, says Prof. Damodaran. If we look around, we see a lot of attempts to measure ESG: there is the Actis Impact Score, Jantzi Social Index, Bloomberg ESG scores, and the list goes on. The real question here is not a lack of metrics, but rather, the lack of a standardised scoreboard – a proprietary score that precisely measures impact for all. Presently, while it is true that we lack a common score to quantify ESG, ESG factors are already systematically accounted for, in the investment process, in a manner that aligns with the value proposition and investment style of the firm or product offering.
Professor Damodaran asks: “Do companies perform better because they are socially conscious (good) companies, or do companies that are doing well find it easier to do good?” While there is truth in the latter argument due to having more and better resources to deal with ESG considerations, it does not mean that the former is completely irrelevant. They are simply not mutually exclusive. For instance, in the ninth edition of Singapore Business Review’s 20 Hottest Startups, ESG grabs spotlight as startups like SEPPURE now focus on ESG practices. As Venture Capitalists now look for startups that value ESG, push and pull all contribute to the trend towards ESG.
Opponents of ESG methodology such as Alicia Munnell raise doubts about the correlation between ESG and the financial performance of companies. However in her analysis, selection bias plays a part here – if you intentionally only look at a limited and oddly skewed sample of ESG funds that underperform the market, that’s likely going to be the conclusion you’d get. In Munnell’s examples of a group of ESG funds underperforming the S&P 500 index SPX, only a mere one-third of the funds are U.S. large-cap funds, most are sector-specific funds of various capitalization sizes, two invest in non-U.S. equities, and one is a U.S. midcap fund. Hence, the S&P 500 is simply not an appropriate benchmark for these examples cited. In fact, Morgan Stanley’s review of sustainable mutual funds in existence for seven or more years found that sustainable equity mutual funds had equal or higher median returns and equal or lower volatility than traditional funds for 64% of the periods examined.
Covid-19 provides a watershed for ESG – acting as a catalyst for it to gain traction. The pandemic has shown that companies do not exist in a vacuum and that they are very closely related to the social and environmental challenges that you and I face. The journey to discover ESG is far from over, and the correlation between ESD and performance need to be explored further. The final verdict is yet to come.
References:
- Munnell, A. (2019): Opinion: ESG — or socially responsible — funds may soothe your conscience but could weaken your portfolio. Retrieved on 5 October 2020, from: https://www.marketwatch.com/story/esg-is-simply-a-fancy-name-for-socially-responsible-investing-2019-06-25
- Damodaran, A. (2020): Sounding good or Doing good? A Skeptical Look at ESG. Retrieved on 5 October 2020, from: http://aswathdamodaran.blogspot.com/2020/09/sounding-good-or-doing-good-skeptical.html?m=1
Jia Xin Neo | LinkedIn
Jia Xin Neo is a student at Nanyang Business School in Singapore studying towards a degree in Bachelor of Accountancy. Jia Xin has worked as a Private Equity Intern at JI Capital Partners which sparked her passion about impact investing and venture capital. Currently she is a Research and Development Intern at Zingforce Ventures, a Singapore-based venture building and advisory firm.