Five ESG myths busted!
This is a guest post by Mohini Singh, ACA, Director of Financial Reporting Policy at CFA Institute.
The demand for sustainability information continues to grow as businesses are increasingly focused on environmental, social and governance (ESG) issues. Investors need it in order to assess how companies are managing these questions and the impact they have on a company’s long-term performance. International securities regulators are also increasingly interested in such information as investing in ESG funds grows in popularity amid increasing concerns about issues such as climate change, diversity, inclusion and labor practices. Yet while ESG may be a hot topic there remain significant areas of misunderstanding, which I hope to clarify.
Myth 1: ‘ESG Investing’
We at CFA Institute have had members (particularly in the US) asking us to tell them about ‘ESG investing’. We have to start by explaining that there is no such thing as ESG investing – there is simply investing. ESG is just another prism through which to analyze your investments.
Myth 2: There is no need to consider ESG factors
The logical next question for our members to ask is why they should trouble to analyze their investments through this prism – but the fact that “ESG investing” is not a helpful term does not detract from the weightiness of ESG factors. The answer is that an ESG analysis is complimentary to companies’ fundamental analysis and therefore results in a more thorough overall analysis of investments that should, theoretically, yield higher returns. I say theoretically because we don’t have the data (yet) to prove this explicitly, but evidence is accumulating that strong ESG strategies consistently outperform conventional investing.
Myth 3: ESG Screening vs. ESG Integration: interchangeable?
When it comes to ESG many people confuse the concepts of screening and integration. ESG screening refers to the exclusion of specific “sin stocks” such as oil, alcohol, tobacco, casinos and firearms. ESG integration on the other hand means the inclusion of material ESG factors into the investment process, a more fundamental adjustment.
Myth 4: Virtue means loss of financial performance!
It is not true that you can either invest sustainably or seek competitive return. You can do both. Increasingly, investment managers are taking an inclusive approach to sustainability, integrating ESG factors throughout the investment process. As mentioned above, the evidence suggests that ESG investments are performing above average, and in particular they have shown to be resilient during the market crash brought about by coronavirus.
Myth 5: There is no need for companies to structure ESG disclosures
Currently, since regulators don’t require it, companies don’t structure their ESG disclosures – which means that they are not machine readable. Since structuring the information enables it to be more efficiently consumed by investors and other users, data providers have started structuring that data themselves for their investment clients. In doing so they analyze the information provided by the company and provide them an ESG score and ascribe to them a story. If companies take control and structure their own disclosures, they can tell their own story and improve communication with investors.
Looking ahead, there’s little doubt that structured ESG disclosure is on the horizon for many. In the EU, for example, mandatory digital reporting of financial data is rolling out under the European Single Electronic Format (ESEF), and it seems likely that ESG reporting will also be going digital in the near future. Other countries and regions will no doubt follow suit. As efforts towards global ESG reporting standards begin to coalesce, the utility of these disclosures will increase, providing investors with more reliable and more comparable information.