ESG-based investing efforts and their related operational adjustments are getting real for many securities firms. And the ESG push is beginning to blur many lines that many never questioned before.
For those who have not been following ESG too closely, the Investopedia website offers a succinct definition: “Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.”
The demands for ESG-based investment strategies, portfolios, disclosures, and so on are causing multiple challenges for firms as they struggle to find the unstructured and unconventional data needed to verify ESG-based decision-making. Such decisions can get complicated without the right data. Performance measurement teams for firms are also getting caught up in the growing demands for the many aspects of ESG compliance. Portfolio managers, customer service groups, and advisors are all under pressure to meet ESG demands.
Yet the interesting thing about the securities industry’s response to the ESG phenomenon is that this more humane, holistic set of benchmarks means that the issuers and the firms involved in the investment process can no longer just deliver great bottom-line results. They must clear ESG hurdles or they’re in definite trouble. The line between good-to-great investments and bad ones is getting blurrier by the minute.
In fact, beyond the pension funds and their ESG forays, the ESG push could change the basic definition of the role of a hedge fund/investment firm/asset manager/buy-side firm/etc. Do these firms exist strictly for the bottom line or do they have a greater financially and socially responsible role to play? And how do they reconcile ESG compliance against less than stellar or worse returns? How ESG-oriented will be the responses of disgruntled pensioners and investors burnt by well-meaning initiatives that flopped? Is Wall Street moving to a Broadway model?
On the flip side, if the returns on ESG-based investments turn out to boost the bottom line, does that mean investment strategies are profoundly changed for the future?
And, just to complicate matters even more, it looks as if there is another substantial battle ahead between those who enthusiastically embrace ESG-based investing and those who do not.
A backlash may be underway via an association of conservative state legislators known as the American Legislative Exchange Council (ALEC), which wants state pensions to refocus just on the bottom line rather than on ESG benchmarks. (Please check out our story running this week.)
ALEC’s backers are proposing a U-turn for the frameworks of state pensions via a new model that “strengthens fiduciary rules to protect pensioners from politically driven investment strategies. These strategies reduce investment returns over the long term which leads to underfunding in state pension plans across the country.”
The ALEC organization has been influential in the past in getting many of its concerns written into bills that were then up for consideration. At the same time, those groups that have pushed to make ESG concerns real have no intention of stopping now.
It may be that what is going on is more than a blurring of lines but an erasure until new lines are formed.
It will be interesting to see if those lines turn out to be guidelines or new battle lines.