There are widespread claims that ESG investing positively impacts the climate and society – as well as delivers better returns compared with traditional approaches. But do these claims hold up under scrutiny? Professor Alex Edmans reveals where the reality diverges from the rhetoric.
ESG (Environmental, Social and Governance) investing is evolving fast and becoming increasingly complex. In this interview, Professor at the London Business School and author of the book May Contain Lies, Alex Edmans, dismantles common myths and explains why trade-offs matter.
What are the key developments in ESG investing?
The first is granularity. ESG used to be viewed as a homogeneous entity, with advocates assuming that all ESG factors pay off. Yet while some are positively linked to returns (e.g. employee satisfaction), others are not (e.g. emissions reduction).
The second is moderation. Even ESG dimensions that do pay off exhibit diminishing returns: more is not always better.
The third is trade-offs, not only between financial and societal returns, but also among different societal goals. Decarbonisation benefits the planet, but many citizens cannot afford renewable energy and in Africa, 600 million people still lack access to electricity.
What are the main pros and cons of ESG investing according to ESG criteria?
The main advantage is that some ESG issues are financially material but underpriced by the market for two reasons: First, many investors do not recognise they’re material, perhaps viewing them as “woke”. Second, even if they acknowledge their importance, they are intangible. Factors such as employee satisfaction are difficult to measure.
The main disadvantage is that many investors view ESG as a panacea. They think a high ESG rating automatically means that a company is a good investment. However, not all ESG issues pay off, and even if they do, they may exhibit diminishing returns.
Can investors make a positive impact on society through ESG investing?
This is a common claim and many ESG funds have attracted clients on this basis. Investors’ impact is much more limited than often assumed. Divestment does not deprive a company of capital, because you can only sell shares if someone else buys. Selling may slightly lower the stock price and make future fundraising harder, but these effects are modest.
Engagement is similarly limited, because it’s difficult to get company directors to sacrifice long-term financial value given their fiduciary duty. The most effective engagements target issues that create financial as well as societal returns, such as reducing resource usage.
Is greenwashing still an issue in the financial industry today?
I would say more than ever. ESG is becoming increasingly tick-box, driven by expanding regulation, disclosure requirements, client questionnaires, and league tables. Many investors “hit the target, miss the point”. For example, an asset manager may advertise that it votes for 100% of ESG shareholder proposals, but this can mean supporting resolutions on immaterial issues. It takes no skill to simply vote for a proposal – the skill is in discerning which ones to support.
What is the single most important ESG tip for investors?
Do not view ESG as a magic word (for advocates) or a curse word (for sceptics). ESG factors are just like any investment – some investments pay off, others do not. Investors should not put ESG on a pedestal compared to other value drivers such as productivity, innovation, and capital allocation. Nor should ESG be privileged over other drivers.
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This interview is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
