Has ESG peaked? Investors cannot stop climate change alone

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A generation of investors is wedded to the promise that sustainable businesses will be profitable over the long term, writes Laurie Hays.

Robin Van Lonkhuijsen/ANP/AFP via Getty Images

About the Author: Laurie Hays is the founder of Laurie Hays & Associatesa communications consulting firm.

Will the first crack in environmental, social and governance investments lead to a flood of desertions?

In May, after regulatory repression and rising energy prices, the largest class of ESG ETFs saw outflows for the first time in nearly six years, according to Bloomberg.

Last month, total ESG inflows were barely positive, in relative terms, at around $400 million, while in 2021 flows averaged $11 billion and doubled to over $20 billion. . More importantly, equity flows were negative, with just over $200 million leaving the ESG ETF universe. Flows into bond, commodity and alternative ETFs made up the difference.

The resulting decline in equity ETF net flows – and the plateau in cumulative flows to the asset class – means that 2022 now lags 2020 and investment is less than a third of the rhythm of 2021, continues the analysis.

In the early days of the ESG investing craze, the theory held that investors seeking fit-for-the-bill companies would drive change and raise stock prices accordingly. Companies with high ESG scores would become more attractive because they would do more to save the planet, help their employees and adhere to good governance.

Assets managed by professionals with ESG mandates reached $46 trillion globally in 2021, representing nearly 40% of all assets under management, according to Deloitte’s Center for Financial Services. By 2024, this figure is expected to reach $80 trillion, more than half of all professionally managed assets.

Admittedly, a quarter is not trending. The momentum and marketing behind ESG is not likely to disappear overnight. And in many cases, the social purpose is more than an investment theory; employees at many companies are pressuring management to also adhere to ESG principles. A whole generation is attached to the promise that sustainable businesses will be profitable in the long term.

As Barrons reported, by shunning traditional energy stocks and defense stocks, which are having a banner year, and embracing low-carbon tech stocks, which are not, many ESG funds lost money in the first quarter and underperformed their benchmarks. And in the first quarter, flows to ESG funds continued.

Long-term investors will be able to wait for the inevitable switch to new energy, but as Germany turns on its coal-fired power plants to make up for the loss of Russian oil, it could take some time.

Most investors probably don’t have enough patience and transparency in ESG practices to bet their retirement dollars on propelling the transformation of companies into sustainable ones.

Climate is a long-term systemic risk that runs counter to the short-term market performance imperative. The reform will not produce returns fast enough to satisfy the brand. Trillions in retirement savings cannot revolve around the price or politics of fossil fuels.

It turned out that the calculation of climate risk versus bottom line had too many variables to easily index and rank. The Securities and Exchange Commission is getting into the picture, but so far it’s focused on fixing companies’ broken promises rather than setting a set of standards. Sorting out public relations that have not been sufficiently supervised on the legal side is a fruit at hand.

Public relations can turn into deliberate “greenwashing,” the practice of giving investors misleading claims about products or environmental, social and governance credentials. The SEC is widely reported to be investigating Goldman Sachs’ mutual fund activities in its asset management arm, which may violate ESG measures promised in marketing materials. According to the Wall Street Journal, representatives from Goldman Sachs declined to comment.

Last month, the chief executive of Deutsche Bank’s asset management subsidiary, DWS Group, resigned a day after German authorities raided its Frankfurt offices over allegations of greenwashing. DWS has repeatedly denied misleading investors, according to Reuters.

Societal issues may be too controversial for institutional investors to dwell on. It’s hard to get everyone on board for abortion, gay rights, and gun control. The most successful governance campaigns have focused on CEO compensation.

Where will institutional investors who withdraw from ESG funds go? The S&P Oil & Gas Exploration & Production ETF is up 68% year-to-date through June 7, with a significant portion of that surge occurring in May, according to Bloomberg.

Meanwhile, as the global economy turns and fossil fuel use continues to soar, news on the climate front is getting gloomier by the month. Scientists reported last month that the atmospheric concentration of heat-trapping CO2 had reached its highest level in four million years, reaching 421 parts per million.

As energy expert Vaclav Smil notes in his new book, How the world really works, from 1989 to 2019, anthropogenic greenhouse gas emissions increased by 67%. And, despite all the happy rhetoric about slowing climate change, developed countries have only reduced their greenhouse gas emissions by 4%.

As Smil argues in an essay published in Yale Environment 360, it’s time to move beyond “wishful thinking” — and hype — and focus on the hard work of overhauling our energy system.

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Teresa H. Sadler