Countering ESG Critics

The whole notion of responsible investing—or specifically aligning an institution’s investments with its mission and purpose—continues to gain traction. But dramatic growth has attracted greater scrutiny. Recent articles in in both academia and the financial media have raised concerns about whether responsible investing is really all it’s cracked up to be. On a recent episode of the “Inspired Investing” podcast, we sifted through some fact, some fiction, and most importantly, some key nuances for fiduciaries when it comes to responsible investing. You can listen here or read the transcript below, which has been edited for length and clarity.

Clare Golla: Welcome to Inspired Investing. I'm your host, Clare Golla, Head of Foundation and Institutional Advisory at Bernstein. On this podcast, we connect and share insights with listeners who are engaged in the nonprofit and broader philanthropy sector. I could think of no one better to help us get to the bottom of this current ESG debate than my colleague Travis Allen—Bernstein’s National Managing Director for Purpose Driven Strategies. Welcome, Travis.

Travis Allen: Thank you, Clare.

Clare Golla: So, as you know, ESG has come under fire lately. A few well-placed articles have prompted questions from investment committees, wondering whether ESG belongs in their organization's portfolios. What do you say to fiduciaries who are feeling uncertain these days?

Travis Allen: First, I would say that this is a healthy conversation for fiduciaries to have. It’s actually part of their responsibility to think about the appropriateness of different types of investment strategies. The thing I would warn them about, though, is making knee-jerk decisions based on a particular article or latest finding. What they really need to do is to take a step back. Think about the origins of their interest in ESG. Is it aligned with their mission and values? What was the original prompt for them to move in this direction?

From there, find the right point of integration with the tools that are available to them. And there are a lot of them—there’s a broad set of environmental, social, and governance investment approaches that are available.

And so, I think that committees are actually in a good place. But the last thing I would just say is that it doesn’t have to be all or nothing. Some boards or committees may decide that they want to have certain portions of their portfolio emphasize environmental, social, and governance issues while in other portions of their portfolio not be as focused. And that’s okay, too.

Clare Golla: Yeah, it’s a great point. And I love that you went back to the origin and the why. Why are we doing this in the first place? And it’s important to say, we love getting these questions because it does mean that fiduciaries are fulfilling their duty. They are asking these questions on behalf of the institution. But we know that to align your portfolio with your purpose, that’s going to look very different from one organization to the next. So maybe from there you could address some of the overarching flaws that you’ve seen in some of the points that have been raised recently?

Travis Allen: First, let me just say that there are very valid questions being asked about the broad category of ESG. But that doesn’t mean that investing with an ESG focus is without merit. It may just mean that it requires an additional level of due diligence for fiduciary committees.

The second thing I would say that makes this a difficult conversation is that when you see articles that say, “ESG is good or ESG is bad,” they're really talking about such a broad suite of potential environmental, social, and governance responses. Some strategies just do integration, and some do divestment, and some do positive screening. Lumping everything in together is really counter- productive and it’s just not helpful.

It’s important to get one or two levels deeper than that and say, “What is it this ESG manager is doing and what impact, if any, does it have on risk and return? And what impact does it have in terms of responsibility? How are they measuring that?” But the focus oftentimes is, “ESG is good for performance, or ESG is bad for performance.” And with those types of arguments you’re always going to be able to find data to support the viewpoint that you already have. It’s much more important for a fiduciary to focus on what are managers actually doing, as opposed to this broad-based good or bad right now.

Clare Golla: Let’s unpack this a little bit because one of the arguments that’s been made is around the whole greenwashing phenomenon. That some companies are engaged in certain activities, regardless of what else they do or accomplish in the world. And they’re framing it as environmentally sustainable activities or socially responsible. How would you respond to that?

Travis Allen: Greenwashing is a very serious issue. All you have to do is to look at the corporate social responsibility reports for various companies, and you might be tempted to think, “This is like a philanthropy, right?”

One of the criticisms that has been leveled is that companies are really wasting resources by producing these reports. That they’re just greenwashing, and they don’t add a lot of value. I disagree. I know that the reports can get better, and I know that the reports include a lot of fluff oftentimes. But it’s very hard to imagine a world where there’s a greater level of accountability if we don't also have transparency and an ability to measure companies.

Rather than saying, don’t bother telling us anything, we should say, “It’s great that you’re sharing more about the gender diversity at your company. But what we’d really like to understand is how that's reflected in compensation, how is that reflected in promotions.” And then work with companies to get them to better disclose that information because we believe it has a material impact on the company's long-term corporate financial performance. And then engage with them on that.

And that’s been the focus for us. For example, engagements are a really big part of what we do from an ESG standpoint. Talking to companies about best practices, talking to them about the need for transparency and then holding them accountable and checking in so that we can measure whether or not they’re truly making progress. It’s a big piece that is oftentimes missing in these discussions about good ESG or bad ESG.

Clare Golla: It is so interesting when you look at some of these corporate social responsibility reports. I think about my background in community development banking. And you know, every bank is required through the Community Reinvestment Act to invest in underserved communities. And you look at reports from any given bank and think, “Wow, that’s astonishing!” But then you look at everything that a community development financial institution does. And then you’re like, “Oh, I get it, that is really a financial institution that is committed to this.”

So, it’s all about the research, but I love that you also mentioned the measurement. Not just doing the due diligence and really understanding and engaging with a company, but then continuing to see if that needle is moving on those specific metrics that you’ve agreed upon over time.

Travis Allen: The thing I like about your example is that it allows you to then ask, “What are you doing that goes beyond the things you have to do?” That's why you need the transparency. And again, we’re not doing this just because it’s designed to make people feel good. We also want to understand the financial impact of those activities as well.

One of the things that I find so interesting about this discussion is that no one ever said, “ESG strategies should get a pass on performance.” I insist that they should be held to the same performance standards—both in terms of returns, but also risk—as other actively managed strategies. So, for fiduciaries out there, just because something has ESG in the name doesn’t mean that you’re not going to evaluate it in the same rigorous way that you do other strategies.

The goal should be to deliver similar risk and return as other traditional actively managed strategies. But with this additional benefit of measurably better environmental, social, and governance outcomes. And so that is one of the things that hopefully will give fiduciaries a path forward. Remember that you also are responsible for measuring risk and returns in the same way you do for other strategies in your portfolio.

Clare Golla: There are uncovered opportunities as well that a focus on environmental and social and governance factors brings to investors. I think about our hedge fund strategy that is focused on climate change. There are other strategies that focus on the Sustainable Development Goals. These are true investment opportunities that come out of the need for certain changes across the globe.

I'm going to pivot a little bit and we’re going to do a bit of a lightning round. The first question is about fiduciaries who come back and say, “Well, there’s no evidence that ESG improves performance.” How do you respond to that?

Travis Allen: I say, look, environmental, social, and governance research is a part of getting a better sense for the investments that you’re making in a portfolio. But there are a lot of other variables that can drive the performance of a stock in the short term. I don’t think it’s reasonable to claim that ESG outperforms or ESG underperforms. It’s one of many inputs into the investment process.

I do believe that by including environmental, social, and governance research and thinking about things beyond the items you can see on financial statements, you get a better sense of what the risks and opportunities are for a given company. As I stated before, the objective is to deliver competitive returns similar to other actively managed strategies, but then also measure the ESG benefits.

Clare Golla: I think as co-fiduciaries, we’re held to a certain standard with traditional financial metrics, and there are plenty of different paths to get there. So, I think that’s a great point.

Next is the Wild West argument: there’s no consensus on ESG ratings and there are different providers out there using different methodologies. How would you respond?

Travis Allen: There is a big deal about ESG ratings and there are many, many inconsistencies. People ask, “How can an ESG analysis be valid when one ESG rating company thinks X and another thinks Y about the same stock or bond?” I'll just say that I don’t think we should want to live in a world where all the ESG rating companies agree on everything. I think it’s healthy to have different viewpoints about the ESG performance of companies in the same way that we wouldn’t want all sell-side analysts to have the exact same financial outlook for a company.

But here’s the key: You can’t just rely on the ESG ratings. Investment managers overseeing these strategies must have their own ability to evaluate the ESG risks and opportunities. They have to do their own research in the same way that bond portfolio managers do. Bond managers will review the credit ratings of the bonds that they’re putting in a portfolio, but they just don’t solely rely on those credit ratings. They create their own viewpoint by upgrading or downgrading and so on. And I think in the same way, ESG ratings should be used as an input. And if that’s the case, then you want to get as many different viewpoints as possible to help you fully understand the risk and return.

So, I don’t understand this argument that the ESG ratings are a waste of time because they don’t all agree. I will say they’re still developing, and the information is getting better. But there is absolutely some useful information that you can take from them today, provided you don’t rely on them exclusively.

Clare Golla: That’s a fair point. You need diversity of perspectives to get to a better understanding, and potentially over time, there may be more accountability right across the industry. But in the meantime, it’s a healthy environment to have multiple inputs, and that’s what we’ve always done as a research firm. We’re constantly looking at different data points.

How about this one: Investment companies are just creating more product, labeling it ESG to make more money. What’s your response to that?

Travis Allen: If you look at flows, I can understand why people make that argument. A lot of money is flowing into ESG investment strategies. But I don’t think that investment companies are so powerful that if they create a product, it just automatically will generate flows. I think what’s really happening is that there has been client demand for investing through this lens long before we’ve had the proliferation of ESG product. And I think what we’re experiencing is that client demand finally has a place to go.

Let’s say that five years ago, 20% of the American population wanted to buy EVs. Well, we weren't manufacturing enough EVs at that point for everybody to get into one. My point is that it’s really client demand that’s driving this adoption that you see as opposed to investment managers coming up with brilliant product. I think they’re just coming up with product that meet the needs that clients are asking for.

Clare Golla: The last one here, I’d love to get your feedback on this. There has been an argument that the “G” in ESG (or governance) doesn’t belong because every company needs good governance, every company needs this system of checks and balances for basic risk management. How would you respond?

Travis Allen: It’s true that every company needs strong governance to provide checks and balances for decisions that are being made by the management team. Ignoring those risks could have serious long-term financial implications. Just like ignoring the environmental and social risks can have long term financial implications for a company.

Think about all the companies that have faced significant financial implications because of some environmental risk that was ignored for too long or a lack of transparency, clarity, or policies from a social standpoint. Think about all the scandals we’ve seen recently. With employees coming forward saying this is not a healthy place to work. These issues are material in addition to governance and so environmental and social issues are just as relevant, in my view, as governance issues in understanding the long-term risks that you face in investing in companies.

Clare Golla: I see it similarly in that, of course, governance is important to the risk management of a company. And to your point, so are these other factors. Look, we are out of time. Thank you so much for joining me and all of you out there in the audience. For more on the nuances of ESG, check out our Responsible Investing microsite. That’s where you'll find blogs, white papers, and links to Travis’ own podcast On Purpose.

Travis Allen: It was my pleasure. Always happy to come back.