Investors Are Coming to Grips with ESG

By David McDonough, founder and CEO of Commonstock

In recent years, the option to invest in environmental, social, and governance-focused companies and funds has muscled its way into our collective portfolio decision-making. Platforms like Robinhood have made it easier than ever to take on positions that align with your values, something many newer retail investors have been very interested in. But turbulent times often test the mettle of one’s convictions. Amid this period, will investing in ESG become less popular?

At Commonstock we regularly run polls on the platform to stimulate discussion around investment ideas. A recent one asking users, “What does an ESG score mean?” confirms that there is strong awareness of ESG and its meaning, but follow-on comments reflect that there are also concerns: “Does ESG really work?” and “How does it fit in with what is currently going on in the markets?”

I believe ESG-driven strategies do work as investing is a long-term game and the fundamentals driving the ESG investment movement are powerful secular forces that will be critical in shaping how we live, work, conduct business, and govern our societies. That being said, ESG is currently facing some real challenges that need to be overcome. If they are addressed there is no doubt in my mind that it will secure a place as a key investment strategy in the decades to come.

Let’s take a closer look. In 2020, net new assets into ESG funds jumped to $51.1 billion — more than double the year before. And last year, these funds attracted nearly $70 billion in new assets, according to data from Morningstar. ESG has been on a roll, but as of recently this picture has changed. As performance faltered this year there has been a fall of investments of over 35 percent -- the sharpest slowdown in three years.

To turn this around, ambiguity around the definition of ESG, greenwashing, and governments developing new stances on energy in the wake of war in Ukraine need to be addressed.

Since it was introduced, ESG has morphed into becoming an incredibly broad catch-all phrase for any kind of strategy that promises to bring about positive social or environmental change. Who governs this? What are the agreed upon standards and measurements? Unfortunately, the nebulous nature of ESG has made it possible for some companies and investors to make empty claims about their contributions and credentials. This was highlighted by a recent raid of an asset manager and Deutsche Bank, which took place in May, after a whistle-blower alerted authorities that misleading statements were being made in annual reports. While adding fuel to fire for critics brushing ESG off as “marketing jargon” I see it as ushering in a new era where authorities and regulators will hold companies and funds accountable for any attempted greenwashing with stricter definitions put in place.

As they say – it’s complicated. Energy is another issue that is raising a lot of questions when it comes to ESG investing. The war in Ukraine as we all know has caused oil and gas companies to skyrocket due to concerns over Russian supply. Many countries are right now making difficult energy policy decisions about shifts away from renewables to fossil fuels based on necessity. Companies with ambitious promises to cut carbon emissions may not be able to do so and deliver a profit to investors. Should they then lose their ESG credentials? Do we need to temporarily redefine what ESG and sustainable investing is until the acute energy crisis has been resolved? These are difficult questions without obvious answers that need to be answered by the ESG community.

ESG investors need to bear in mind that all will not be straightforward in the months ahead. There are plenty of risk factors, volatility and unknowns. Recent ESG fund performance has no doubt been hit by a unique set of circumstances but there clearly are long term tailwinds. A recent report from management consultancy Bain & Company found that three-quarters of high-earning millennials think that ESG is “an important factor in investment decisions.” Bain forecasts that around half of all assets under management by 2030 will be “ESG-related”, up from around a third today.

I say, hang in there, focus on getting the right information, be prepared to make long-term investments and lean into the promise of capitalizing on the opportunities to invest in businesses with environmental and social principles.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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