According to the World Bank, the loss of biodiversity and ecosystem services would cost the global economy $2.7 trillion by 2030.
This question can be interpreted in a variety of ways. If an investment is not sustainable, it is unlikely to be considered an asset—end of story. Yet, investing in environmentally friendly firms and initiatives is gradually emerging as an investment category, promising lower risk and higher profits while combating climate change and encouraging diversity. According to Bloomberg, investment in ESG (Environmental, Social, and Governance) assets is expected to exceed $53 trillion by 2025, accounting for more than a third of the anticipated total assets under management of $140.5 trillion.
However, sustainable investing has been heavily criticised. Former BlackRock sustainable investment chief Tariq Fancy called ESG a “dangerous placebo,” and the Wall Street Journal ran a week-long series of rebuttals to the movement, with the first article headlined “Why the Sustainable Investment Craze is Flawed.” It might be difficult for an inexperienced investor to determine who to believe. So, if we peel away all the hype and look at the facts, does sustainable investing genuinely help the environment? A growing number of investors, particularly young ones, are willing to fund enterprises that are concerned about climate change and are socially responsible. According to the United Nations, 84% of asset owners are pursuing or actively considering sustainable investments.
But does sustainable investment bring in more capital? To answer this question, we need to consider the three objectives that investors have when buying ESG assets:
The first objective is, unsurprisingly, financial. Investing in sustainable companies increases returns while avoiding unsustainable ones reduces risk. At least, that’s how it appears on paper. However, there is evidence that certain aspects of ESG do pay it forward. According to a report published in the Academy of Management Perspectives, assets in these funds increased 52% to $362 billion between 2020 and the end of 2021. According to Broadridge Financial Solutions, ESG assets could be worth $30 trillion by 2030.
The fundamental issue with ESG is its confirmation bias. Because we want to believe that ethical businesses perform better, we cling to research that supports this view, even if the data is weak. Eye-catching articles insist that “investing in ESG pays off,” but arguing whether ESG helps or hinders returns is as futile as asking whether food is good or bad for you – it depends on the food.
The second objective is company behaviour. Divestment campaigns encourage shareholders to sell stock in specific companies in order to discourage new investors from purchasing. So, for example, by divesting fossil fuel firms, we may strip them of funds and prevent them from polluting the environment further. However, investor boycotts do not necessarily deprive a company of funds because you can only sell your stocks if someone is ready to buy them. They are not the same as customer boycotts, which cost the company money.
Okay, so maybe divestment does not pull the plug on a company immediately, but it does make it harder for them to sell shares in the future, right? Well, not necessarily. Because they are mature sectors with limited growth potential, “brown” companies such as fossil fuels and tobacco do not make much capital to begin with. If a fossil firm knows it will be divested regardless of what it does, it has no incentive to produce clean energy. However, if the company is promised that its shares will be purchased if it leads its sector in sustainability, it will be motivated to clean up its act by investing more in reducing emissions.
The final objective is moral. Is it wise to make long-term investments? For example, even if sustainable enterprises do not perform well, funding them as an expression of your principles seems fair. However, recognising moral businesses is difficult since many fundamental components of morality are challenging to see. A corporation could appoint minorities to its board of directors to tick the diversity box while doing nothing to foster an inclusive atmosphere. According to Influence Map, a U.K. think tank, 723 equity funds adopting ESG claims in their marketing were not aligned with the Paris Agreement’s goal of keeping global temperatures below 2°C above pre-industrial levels.
While the sustainable investment movement remains hopeful, drastic reform is required to ensure the backlash outweighs its potential benefits. The movement’s Achilles heel is that its supporters risk exaggerating its benefits, which invites criticism. Elon Musk, among many critics, recently labelled ESG investing a “scam.” The backlash grows, combining those on the left who believe capitalism cannot be reformed and those on the right who regard ESG as an attempt to impose irrationally “woke” leftist values on the financial world.
The recent expansion of sustainable investing has been made on shaky foundations, since several financial firms have been exposed for exaggerating their ESG credentials. To measure a company’s sustainability performance, it may rely on flawed metrics based on insufficient research or “ESG ratings.” These techniques are frequently entirely subjective regarding what constitutes acceptable business behaviour, which is rarely acknowledged. Those supporting ESG funds tend to underplay the risks ESG investors may encounter while investing in a sustainable company.
So, what needs to change? We require consistent, dependable, and transparent financial data on the true impact of sustainability efforts. While criticising the experimental nature of such investing is relatively easy and frequently justified today, now is not the time to give up. Instead, we must continue to emphasise the demand for these items and encourage governments to determine the rules of the game. As a result, better decisions will be made for people, the environment, businesses, and investors.
Author- Amar Chowdhury
