NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

Tuesday, October 6, 2015

The focus should now be on environmental, social and governance investing, along with funds and index products that use these criteria.

Volkswagen was rated as one of the best ESG companies, an endorsement included in key products that claim to offer investors portfolios of the best-behaved companies. Now confidence has been shaken in the notion that being a “good” company must simply mean an outperforming investment. Terms such as “responsible investing” and “sustainable” may need to be re-defined.

Can ESG even be measured accurately? There is a danger of relying on company reports that can be self-serving or misrepresent. The desire to promote ESG has run well ahead of the investment industry’s ability to measure it. The Volkswagen scandal should drive an opportunity for the ESG movement to reassess its claims and improve its practices. It is a broad church that now needs to get more specific, particularly on governance.

Growth area

ESG is meant to deliver long-term investment benefits while also improving society. The claims go beyond simply making asset owners feel good. The spin suggests that companies scoring well on ESG face less strategic risk and should perform better. The appeal is not to investors’ altruism, but their pockets.

There is now a lot of money backing ESG as the future of investment. Not only have indices and exchange-traded funds been set up that buy only these “good companies” and package them for investors. Increasingly, many conventional active investors are trying to integrate the concept within their investment analysis and decision-making.

A recent CFA Institute survey of investment professionals worldwide showed that 73% of them take ESG into account in their investment analysis and decisions. But the same poll highlights the need for third-party verification, given the dangers of relying on company reporting and promises.