A reality check for ESG investing

Perhaps the most vocal critic to emerge from this year’s sustainability frenzy is Tariq Fancy. In a plot twist worthy of Hollywood, the former chief investment officer for sustainable investing at BlackRock published a three-part essay in August describing the ESG investment products he once peddled as a “dangerous placebo” and that the industry is “duping” the public.

He further accuses the industry of pushing ESG products simply to charge higher fees. According to the Wall Street Journal, ESG funds had an average fee of 0.2% at end-2020, while standard baskets of stocks carried fees of 0.14%.

There were robust responses to Fancy’s explosive claims. In a Forbes article from October, Clara Miller, former board member of what is now called the Value Reporting Foundation, thinks Fancy could have surrounded himself with “a stronger set of tutors” and that he was “late to the party”.

“If he had become current in the field, he would have known that there are, and have been for years, tons of similar critiques of ESG, impact investing, sustainable investing, mission-related investing — you name it,” she adds.

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Refinements needed

The debate underscores how this segment of the financial industry has grown; ESG investing is no longer a niche appeal. Refinitiv Lipper estimates that the global value of outstanding ESG funds hit US$4.2 trillion ($5.75 trillion) as at 2QFY2021, more than double from 2017.

A third of total assets under management (AUM) in the US carry the ESG label, but walking the talk may be much harder. Gary Gensler, chairman of the US Securities and Exchange Commission, said in a congressional hearing in October that he was looking at investment fund labels to ensure that there was enough rigour behind their sustainability claims.

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The scrutiny comes from bottom-up too, as retail investors get savvier by the day. In a survey of 908 investors from the US, UK and Singapore by Capital Preferences, a behavioural economics and financial technology firm, three in four investors are not confident that their current portfolios are aligned to their personal ESG values.

In Singapore, only one in five respondents believe their banks or financial advisers have been effective in explaining ESG concepts and terms to them. Even when investors receive ESG reports from their advisers or wealth managers, less than half (46%) say that the reports give them a clear understanding of the impact of their ESG investments.

Those investors may be on to something, as the saying goes: when there is smoke, there is fire. According to the 2020 Barclays report ESG funds: Looking beyond the label, ESG-labelled funds are not really different from conventional funds in terms of holdings, risk exposures and performance.

The lack of a universal ESG reporting standard, long flagged by the industry, may give rise to more issues down the road. Last year’s Aggregate Confusion Project by the Massachusetts Institute of Technology’s Sloan School of Management found “a large level of divergence” among ESG scores from six prominent data providers.

Then, there is the oft-repeated mantra that ESG almost certainly guarantees higher returns. Is this a sustainable outperformance, or one kept afloat by today’s ESG exuberance?

Index provider Scientific Beta collected market participants’ views on its recent white paper, Honey, I Shrunk the ESG Alpha: Risk-Adjusting ESG Portfolio Returns, which questions the popular belief that ESG strategies outperform traditional portfolios.

The study claims that the ESG alpha disappears when adjusted for industry and factor exposures.

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“Most of the respondents agree that there is no sound evidence that ESG strategies offer any incremental value in terms of performance, and that most of the performance is captured by style factors,” says Scientific Beta in a Nov 9 release.

“Only 17% of respondents believe that the finding of absence of outperformance is surprising,” adds the independent index provider, which is 93% owned by the Singapore Exchange (SGX) as at January 2020.

The industry should try and fine-tune the ESG instrument and not throw it away altogether, says Brian Arcese, portfolio manager and equity analyst at Foord Asset Management. “I don’t expect the interest or hype around ESG investing to wane in 2022, nor do I believe the world is getting ahead of itself in highlighting the importance and impact of ESG investing,” Arcese tells The Edge Singapore.

“Based on what we can see, it seems to boil down to three areas of note,” says Arcese. “The lack of standardisation, for example, makes comparisons across ratings agencies nearly impossible.”

“The lack of transparency in how individual ratings agencies develop and evolve their own ratings systems makes comparisons of the same corporate’s rating from one year to the next also quite difficult,” he adds.

“Additionally, a gap in access to resources means that larger corporations have more resources to spend on ESG reporting and the way it is positioned in the market for investors. Therefore, they look more appealing than their smaller and lesser capitalised competitors,” says Arcese.

Foord is an independent boutique asset manager. Established in South Africa, the firm entered Singapore in 2012 and Luxembourg in 2013.

Here in its Asian outpost, Arcese notes that regulators are working to make the ESG picture clearer for all.

For one, the Monetary Authority of Singapore is working towards standardising ESG reporting for both companies and investment managers. Now, only 15% of Asean corporates solicit external guidance on what to report with regard to ESG and less than 3% of SGX-listed firms undergo any type of external ESG audits, says Arcese.

SGX introduced sustainability reporting on a “comply or explain” basis in June 2016. According to the Singapore Exchange Regulation, issuers should begin disclosures on a “comply or explain” basis starting FY2022. Climaterelated disclosures will be made mandatory for certain sectors from FY2023 onwards, with more sectors included in FY2024.

“Further standardisation and clarification will aid companies and investors in making better-informed decisions,” adds Arcese.

Data and transparency will play an important role for companies to avoid accusations of greenwashing, says Nick Merritt, project finance and sustainability partner for Singapore at Norton Rose Fulbright.

Speaking at the law firm’s sustainability media roundtable on Dec 1, Merritt points to recent attempts at developing a “global taxonomy and architecture” on sustainability reporting. “The creation of the International Sustainability Standards Board has been announced and is supported by world leaders including G20, OECD and European Union. Companies will likely be required to undertake mandatory non-financial reporting in the coming years.”

Over time, such reporting will become second nature for companies and investors, says Foord’s Arcese. “Just as investors look through financial statements and business plans today, they will also look through the firm’s standardised status on several ESG factors, and what direction or actions the firm is taking to improve these metrics.”

Too little, too late?

The financial industry may be split on the best measurement, but could we be off by a mile? ESG funds concern themselves with much more than just climate change mitigation, and the 17 United Nations Sustainable Development Goals (UN SDGs) are a popular measure for comprehensive progress.

Launched in 2015, the UN SDGs are a global call to action to end poverty, protect the planet and ensure all people enjoy peace and prosperity by 2030. That deadline may have appeared catchy and sufficiently faraway six years ago, but it is now fast approaching.

According to London-based investment manager M&G Investments’ SDG Reckoning report, the world is on track to deliver only six of the 17 goals.

Using a scale of 1 to 10, M&G found an average 2020 progress score of 4.1 across all 17 goals, unchanged from 2019, with nine SDGs seeing no change since last year’s report. Four goals see a notable deterioration, three of which are socially-focused goals: SDG 1 (no poverty), SDG 8 (decent work and economic growth) and SDG 10 (reduced inequalities).

“Our analysis shows that there is still much work to be done globally in delivering on the UN’s 17 goals,” says Ben Constable-Maxwell, head of impact investing at M&G. “This collective effort is needed across the SDGs’ societal mandate, but especially in areas such as poverty alleviation, decent work and better education, which have fallen behind during the pandemic.”

Norton Rose Fulbright’s Merritt emphasises cooperation among corporates over a punitive approach. “If we’re going to achieve the SDGs, it’s not by rules and regulations; it’s by changing behaviour. We’ve got eight years left to achieve the SDGs and 20 years left to achieve net zero.”

The law firm has been working with Hyundai, which is launching its Ioniq 5 electric vehicle in Singapore with a new business model of “batteries-as-a-service”, where car buyers lease batteries from Hyundai instead of owning them as part of the car.

“This brings down the cost of the car for the customer, and Hyundai wants to manage battery performance risks which customers are not familiar with,” says Merritt.

It may sound like a money grab but in this way, Merritt claims Hyundai is contributing to a circular economy. “The smart factory for Hyundai, built in Singapore, will have a bank of these batteries within the building as an energy storage system. As batteries come out of the vehicles, Hyundai ultimately recycles those batteries and brings the minerals and metals back into production, closing the loop.”

Now, fuelling the world’s transition will cost a lot more than just detachable batteries offered under a relatively new business model.

Boston Consulting Group estimates that between now and 2050, US$5 trillion in new equity and debt investment — equivalent to 5% of 2020 world GDP — is required each year to fund the transition of key industries like energy, transportation and manufacturing.

Until a common framework emerges, ESG investing will remain a shot in the dark at improving the future. Some may demand more information, while others are either content with current returns from ESG portfolios or knowing that their funds have at least a chance of effecting real change.

Says Merritt: “I always say to my younger colleagues, if you’re looking for an objective or an ambition for your working career, there’s nothing more exciting or ambitious to be focusing on than the SDGs and net zero.”