TLDR: Environmental, social, and governance-related (ESG) aspects have been playing a role for investors since the 1960s. Making investment decisions based on more than just traditional financial data has two major advantages: First, it gets more capital moving towards more sustainable businesses. Second, it empowers shareholders to actively engage with corporate leadership to find ways of getting a company on a more sustainable path. ESG has found its way into legislation, making it a mainstay for corporates and their financial backers. Investors who understand the mechanisms that link ESG- and financial performance have a huge advantage in comparison to those who do not. This piece was originally published in April 2024.
For almost a century, capitalism has been becoming increasingly aware of its impact on people and the planet. Social rights, environmental preservation, and responsible governance were previously deemed the job of the state. Over the course of many political and financial crises — the Great Depression and the Euro crisis being recent examples — the private sector started getting as much public scrutiny as the government. As a result, private companies and their financiers have increasingly needed to pursue more than just profit.
To respond to public scrutiny, more is needed than a few philanthropic projects and plans that were drafted more for corporate branding than for actual implementation. Companies and their investors need robust frameworks that allow them to evaluate their progress and compare them with their peers. They also need access to high-quality corporate, environmental and social data. While frameworks have been keeping up well with public demands and the newest science, access to high-quality, accurate and timely ESG data remains a big problem despite the plethora of data providers existing today.
ESG has had a long and rich history. ESG investors have enjoyed many advantages vis-à-vis their peers, which goes well beyond having a better public image. Given all the advantages, governments around the world are adopting laws for ESG disclosure and similar measures. One should bear in mind, however, that ESG- or non-financial data has real financial consequences, which makes it all the more interesting for investors.
ESG investing has been getting more and more relevant
In 1928, the US Pioneer Fund was launched. It was the first fund to explicitly identify as responsible. That being said, the ideas for responsible investing had already been developed long before: John Wesley built many of the ideological (and religious) underpinnings with his 1744 sermon “The Use of Money”. Economist Adam Smith also elaborated on the topic in his 1776 seminal work “The Wealth of Nations.” In other words, thinkers had understood the social responsibility that comes with money for a long time; it just took a number of years to put this thinking into practice.
From the 1960s onwards, responsible investing started receiving considerable attention. In particular, the founding of the Club of Rome network in 1968 made waves because of its commitment to providing leaders a space where they could elaborate solutions to complex issues and promote policy initiatives to drive human progress.
By the 1990s, the idea of responsible investing was widely recognized, illustrated by the launch of the Domini 400 Social Index and the Triple Bottom Line accounting framework, the latter of which emphasizes and quantifies profit alongside people and the planet.
Until 2004, responsible investing was known under acronyms like SRI (Socially Responsible Investing) or CSR (Corporate Social Responsibility). Once the acronym ESG was first introduced in the UN’s note “Who Cares Wins,” more and more investors started investigating their contributions to social and planetary good. Note that these concepts and acronyms do differ from one another, but all share the goal of doing something good alongside generating financial returns.
Major advantages of ESG investing
From the point of view of the larger public, there are two main advantages to ESG investing. First, it encourages more capital to flow to sustainable businesses, to the detriment to unsustainable businesses. Second, the presence of ESG frameworks, and increasingly ESG-related regulation, shareholders are better able to influence senior management and encourage them to steer their companies towards a more sustainable future.
For investors themselves, responsibility is often a no-brainer. Pension funds, for example, not only strive to maximize the return on their investment, they also fulfill an important social duty by funding retirement schemes. For other investors it is often enough to consider the sheer weight of the amount of money they manage, and the fact that the allocation of this money might influence economic development for decades to come.
Another important aspect to ESG for investors is risk management. A company that performs poorly in ESG-related metrics might make them look bad or lose their money if they invest in it. For example, their portfolios might become subject to potential risks like labor disputes, legal actions, and adverse publicity, which could ultimately diminish future returns. Hence, keeping track of ESG factors enables investors to make more informed risk assessments.
How regulators are backing ESG
More and more regulators around the world are aiming to standardize and enhance the disclosure of ESG-related information, fostering transparency, accountability, and sustainable practices across businesses of all sizes. The European Union has been at the forefront of this development: Frameworks such as the Corporate Sustainability Reporting Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR) are highly detailed and strict guidelines for companies. They mandate disclosures on various sustainability topics, including environmental impact, social responsibility, human rights, and anti-corruption measures.
Moreover, regulators are taking proactive measures to combat greenwashing. For instance, the UK's Financial Conduct Authority (FCA) is developing Sustainability Disclosure Requirements (SDR) to address greenwashing barriers in sustainable investments. Similarly, Germany's Supply Chain Due Diligence Act (LkSG) holds large companies accountable for observing social and environmental standards across their supply chains, aiming to mitigate human rights abuses and environmental violations globally.
Furthermore, regulators are collaborating internationally to create cohesive and effective ESG frameworks. The US Securities and Exchange Commission (SEC) has proposed climate disclosure rules, reflecting a global trend towards enhancing climate-related disclosures to support investor decision-making. Additionally, efforts by organizations like the International Sustainability Standards Board (ISSB) aim to unify ESG reporting standards, reducing complexity for businesses and investors. Overall, the backing of ESG by regulators worldwide is increasingly ushering in a shift towards a more sustainable and responsible approach to business and investment.
Going beyond non-financial data
In its early stages, ESG investing focused on not investing in harmful sectors like tobacco or gambling, or in countries that were not aligned with investors’ values. In the 1980s, for example, investors divested stakes in companies that were doing business in South Africa to fight against Apartheid.
In recent years, investors have taken a more positive approach: By applying an ESG score to each company, they can identify the best-in-class companies of each sector and choose to invest in these. The downside of this is that ESG scoring methodologies vary wildly from one scoring agency to another, thus making the choice of a best-in-class company a rather difficult task.
More and more, investors are now questioning the non-financial nature of ESG. They are beginning to realize that performance in certain ESG-related variables (for example carbon footprint or worker wages) might have an influence on the company’s financial performance down the road. This means that for many industrial sectors one can pick a small amount of ESG variables to better predict future financial performance. This aligns the return-seeking goal of investors with their will and duty to have a positive and long-lasting impact with their investment decisions.
From a historical point of view, there is a trend of decentralization of social and environmental responsibility: What was formerly the state government’s duty has now fallen into the hands of various economic actors. Investors play a special role herein because their money is leverage for making big things happen. Wangari supports these investors by guiding their investment decisions and aligning their returns with social and planetary good wherever this is possible.
What we’re reading at Wangari
At Wangari, we believe that social and environmental issues are inextricably intertwined. It thus hit us by surprise that laws combining environmental issues with social policies actually have less support from the electorate, not more.
explains in Study: Sweetening climate policies with add-ons designed to engage liberals or conservatives can kick back that the average American voter leans left economically and right socially, which, if left to please the electorate, makes for contradictory legislation. The bottom line is: Passing laws is complex work.An important reminder, penned by
, that carbon removal is still in its infancy and experiencing some teething pain. Red teaming the next ~5 years of carbon removal shows how necessary policy requirements around carbon removal will become, and how financing mechanisms need to be invented or adapted to support big carbon removal plants. Overall, we need many more entrepreneurs starting carbon removal projects.“Don’t be one person.” If there is one takeaway from
’s beautiful piece How to Think Like a Forest, this is it. A forest is more than a collection of trees; its magic comes from the complex interactions that each organism has with the others around it. A third of the food a tree produces goes to animals, which, in exchange, pollinate them, provide them with more carbon dioxide, and so on. The whole world is one big complex interconnected web of life.