ESG – Is it a Fair Indicator?
When investing in companies, businesses should take into account Environmental, Social, and corporate Governance (ESG) metrics.
ESG is many things – a useful tool for understanding business and management as well as helping organisations to follow best-practice – but is ESG a suitable method to account for sustainability?
ESG – The Good and the Bad
The recent energy crisis and rising interest rates have highlighted the need for more renewables, but returns from fossil fuels continue to outperform clean energy. Whilst more firms are looking into ESG, it is not the be all and end all.
ESG fails to capture the complex nature of environmental systems, meaning one size does not fit all. A lack of rules and guidelines results in ESG being a poor indicator for business and investing performance, meaning that not all organisations are directly comparable.
ESG & Shareholder Returns
A number of businesses that rate highly for ESG do not produce better shareholder returns. Similarly, unprincipled companies facing higher funding costs can still perform well and there is little evidence that good ESG organisations generate higher income or growth.
If investors want to have a positive impact, they often look for a company that can make rapid and substantial cuts in its carbon emissions, rather than looking to an organisation that has already reduced its carbon footprint, and thus scores highly on ESG.
What’s more, there’s a growing concern that some companies publicly embrace ESG as a cover for poor business performance.
As a rule of thumb, ESG should be combined with other metrics and investors should not solely rely on ESG to drive investment decisions. On its own, ESG is not a good predictor for business success; instead, companies should focus on obtaining information on processes and systems that impact outcomes, rather than just inputs.