ESG Investing: Short-term Yield vs. Long-term Benefit
Imagine a farmer deciding what crops to plant in a field. The farmer has two different types of seeds to choose from: ‘regular’ seeds and ‘organic’ seeds. The regular seeds will grow quickly and produce a large yield, but they require chemical fertilizers and pesticides, which can harm the environment and the health of the farmer and his family. The organic seeds, on the other hand, will grow more slowly and produce a smaller yield, but they are grown without harmful chemicals and are better for the environment and the farmer’s health.
This is one way to describe ESG investing, a form of socially responsible investing focused on Environmental, Social, and Governance factors. In the above example, the ‘regular’ seeds represent traditional investments that focus solely on financial performance, while the ‘organic’ seeds represent ESG investments that take into account a company’s environmental and social impact. Just like with the regular and organic seeds, an ESG investor has to weigh the potential trade-offs between financial performance and environmental and social impact when making investment decisions. Ultimately, the decision of which seeds to plant (or which investments to make) depends on the individual’s priorities and values.
Investing in ESG companies can be a good way to make money while also having a net positive impact on society and the environment. The driving ideology behind ESG investments is that they’re not only about making money, but also about creating a better world for future generations, a concept which has gained traction in recent years. ESG-labeled investment products can help investors make better decisions about the companies they invest in, by focusing on companies committed to ESG metrics like environmental impact, equitability, diversity, worker safety, and fighting climate-change, while avoiding industries commonly viewed as harmful to society and the environment such as weapons and military hardware, tobacco, fossil fuels, gambling, and others.
As of 2022, ESG is an approximately $3-trillion investment sector, but worries about so-called greenwashing have increased.
Green lipstick on a pig
Greenwashing is the act of misleading consumers about the environmental practices of a company or organization. It is a form of false advertising that can be difficult to detect, and is often used by companies to make themselves look more environmentally friendly than they may really be.
Greenwashing can be done in many different ways, including:
- Giving money to environmental charities while continuing harmful environmental practices
- Creating an environmental program that doesn’t actually do anything
- Using green products in marketing materials but not in day-to-day operations
International financial regulators are putting more rules in place to prevent fund managers and others from suggesting environmental and social benefit when such claims can be dubious
For example in 2022, Germany’s Deutsche Bank was raided by authorities in relation to allegations of marketing investment products more ‘environmentally-friendly’ than they really were.
In January 2022, the Canadian Securities Administrators (CSA) released new guidance for ESG investment fund disclosure. The document reiterated existing regulations that apply to ESG funds, including requiring managers to disclose material or essential strategies in their prospectus or Fund Facts documents, plans to invest primarily in ESG-related issuer types or industry segments, and any intended measurable ESG outcomes of the fund.
The CSA also warned fund managers against making exaggerated or unsubstantiated claims and said any funds with ESG themes in their names – such as “green” or “sustainability” – must reference that aspect in their investment objectives.
While ESG investing is not without its challenges and critics, more and more investors, especially younger investors, are looking to align their values with their investment decisions. As such, ESG investments will likely continue to grow and diversify as a category in the financial landscape. Well-meaning investors should continue to practice due diligence before investing in ESG, and be aware of regulators and non-profit watchdogs’ efforts ensure companies are accountable for their ‘green’ claims.