Return ESG to ‘common-sense’ values investing

NYU Stern Center for Business and Human Rights report argues one composite score makes ESG 'a bundle of contradictions'

While an ill-informed ESG backlash continues to dominate some corners of the globe, in other parts another debate is taking place: should E, S and G themes be siloed and the bundling of ESG disbanded?

It’s a debate that was reignited by a provocative leader in the Economist in 2022, which argued ESG funds should focus solely on emissions, which would limit ‘ESG’ trade-offs, simplify incentives and provide credibility to ratings agencies.

See also: – ‘ESG as a term has outlived its purpose’

The article created mixed reactions, with some arguing focusing solely on emissions would exacerbate the problems it was trying to simplify. “Tesla would no longer need to worry about Li ion batteries’ end of life,” sustainability and digital transformation director at Dell Technologies Karthik Suryanarayanan wrote in a LinkedIn response.

In ESG Clarity last month, Victory Hill head of sustainability Eleanor Smith argued a “wilful blindness to look beyond emissions statistics” is compromising supposedly sustainable portfolios. “If investors fail to consider the broader social, governance and environmental impacts of their investments, they are both incorrectly assessing the impact of their assets and misjudging the trajectory of their investment approach,” she said.

NYU report argues for a return to values investing

However, for others the idea has taken hold. On the ESG Out Loud podcast back in July, economist Trevor Williams told ESG Clarity responsible investment should be about carbon reduction. And today the latest voice to join the fray is Michael Goldhaber, senior research scholar at NYU Stern Center for Business and Human Rights, who has authored a report calling for a return to a “common-sense” understanding of ESG investing that focuses on narrower themes and uses broader exclusions in order to limit the negative impact of business on the environment and society.

“Lumping the E, S, and G into one composite score makes ESG a bundle of contradictions. The solution is to disassemble the bundle,” the report said.

The report, Making ESG real: A return to values-driven investing, which is largely targeting the US ESG investment and regulatory landscape, argues ESG doesn’t lend itself to a composite score, because its factors sometimes work counter to one another, and so funds should instead target narrower objectives. Moreover, because these objectives, or priorities, are highly personal, asset managers should customise ESG portfolios to fit each of their client’s values.

This is a return to the origins of ethical investing, the report argues, and these funds could be called ‘ESG Values’ investing.

“If you take something that is very clearly measurable, like Paris alignments or carbon footprints, and you forget about this incoherent mishmash of ESG and you just say, this is what we’re measuring for and this is what we’re going to label the fund, investors know what values they’re expressing if they choose to,” Goldhaber told ESG Clarity before the launch of the report.

Investors should also be able to choose to prioritise these values over financial returns, the report said, citing a study of impact funds in the Journal of Financial Economics that concluded investors pursuing social impact are willing to forego between 2.5% and 3.7% in annual return.

ESG Value funds would also include a high exclusions threshold. The report said: “Aggressive screening is the surest way to create an ESG fund with holdings that make clients proud, not embarrassed.”

Because of the unproven link between ESG investing and outperformance, the concerns composite scoring raises with ratings agencies, and similarities between ESG and non-ESG funds identified in the report, “the marketplace is ready for a form of ethical investing that corresponds to the original, common-sense un­derstanding of the phrase”, the report said.

“Investors who are strongly committed to social reforms should have more opportunities to take such an approach—call it ESG Values in­vesting—by expressly stating that they prioritise values over value.”

Due to its largely US focus, the report calls for measures that are largely underway or being called for by investors in the EU often under the umbrella of ESG investing. For example, it praises a double materiality approach, and asks regulators to go further in enforcing transparency by ESG raters and asset managers, while mandating more and better data reporting by corporations.

Goldhaber admits sustainable investment taxonomies could provide solutions, but still argues there is a need for thematic investment based on values, which could include, for example, taxonomy-aligned funds.

“There’s a lot of merit in simplicity,” he concluded. “I would like to see fewer targets, with meaningful metrics.”


Natasha Turner

Natasha was global editor at ESG Clarity, part of Mark Allen Financial, and a financial journalist for seven years. She has been shortlisted for Story of the Year and Investment Journalist of the Year...