The Wall Street Journal is Wrong About ESG

Disingenuous claims about ESG serve to muddy the waters regarding its purpose and homogenise short- and long-term investor trends, argues Jon Hale

Jon Hale 1 February, 2022 | 9:35AM
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I suppose it's a sign of success when The Wall Street Journal (WSJ) sees fit to launch a weeklong critique of sustainable investing. After all, it’s one of the world's chief defenders of the status quo. In this case, the status quo is the “shareholder primacy” view of capitalism, supported and enabled by traditional investing.

But the world is moving away from all that. As I wrote last week when I highlighted BlackRock chair Larry Fink's annual letter to CEOs, stakeholder capitalism is now the dish of the day. That is supported and enabled by sustainable investing. Others agree.

"Everyone is holding business to a higher standard," begins a recent Accenture report, Shaping the Sustainable Organization, on how corporations can "create lasting value and equitable impact for all stakeholders."

People want to work for sustainable companies that treat them well and have a positive purpose. Nearly two thirds of employees in a survey conducted for the Accenture report said businesses should be responsible for leaving their people "net better off" through work.

When making consumer purchases, people now more often consider the sustainability of the product and ethics of the company making it. Nearly three quarters of consumers said in the survey they believe "ethical corporate practices are an important reason to choose a brand.” Two thirds said they "plan to make more sustainable or ethical purchases in the next six months."

So people-as-workers and people-as-consumers want to hold business to a higher standard. What about people-as-investors? When Morgan Stanley asked individual investors about their interest in sustainable investing in late 2020, 79% said they were interested and, among an oversampled group of millennials (and this is not a typo) 99% said they were interested. Flows into sustainable funds in the United States and Europe continued to set records in 2021.

Sustainable investing is hardly a "craze" then, as the WSJ put it . Crypto is a craze; SPACs are a craze; day-trading meme stocks during the pandemic is a craze. Sustainable investing is part of a longer-term shift in the way people approach their investments, and it is helping bring about a systemic shift toward stakeholder capitalism. At a time when governments are hamstrung by a variety of limitations in addressing problems like climate change and growing inequality, sustainable corporations can step up to play a greater role. They can be enormously influential.

And what about people-as-citizens? In perhaps the most disingenuous claim made by the article’s author James Mackintosh, he says:

"My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidise the things we think are good." Seriously?

Three Arguments

First off, in the US anyway, navigating our broken dysfunctional political system is hardly a "simpler" path to take for effecting change. Second, sustainable investors can walk and chew gum at the same time. Both in their role as investors and as individual citizens, they can and do support public policy solutions. No one is saying "let's just fight climate change as investors so governments don't have to." No one is saying "I can't be distracted by politics because I'm too busy with my sustainable investing."

Policymakers are hardly going to ignore issues like climate change, improving diversity in the workplace, and strengthening democratic institutions because sustainable investors are growing in number and are concerned about these issues. The fact so many investors are showing such concern over sustainability issues provides greater impetus to act.

Let's take a closer look at three "pro-ESG arguments" that Mackintosh thinks "sound reasonable, but have major flaws."

First is the big picture move toward stakeholder capitalism. Mackintosh's view is that companies focused on creating value for all their stakeholders will ultimately just take on added costs, which will lead to reduced investor returns. This represents a difference in philosophy and an assumption that addressing ESG issues is simply about adding costs, rather than about adding value.

Indeed, there will be winners and losers as we move into the era of stakeholder capitalism. But examples abound of companies moving in this direction. Those that don't try and those that don't get it will struggle to meet their sustainability challenges, which will hurt their profitability.

The second pro-ESG argument Mackintosh says is flawed is the idea that shunning investments in "dirty" companies and embracing "clean" ones means sustainable investing can direct capital away from bad companies and toward good ones, driving up the cost of capital for the former and lowering it for the latter.

He says this is flawed because there is not much evidence demonstrating this has happened, except perhaps in the case of energy companies. However, this is not really an argument central to sustainable investing. It's more a theoretical implication often discussed by academics who have yet to find much of a link. That said, few companies today want to be excluded from ESG indices, and there is growing issuance of sustainability-linked bonds, which lower the cost of borrowing if the issuer meets predefined sustainability objectives.

Moreover, an academic study just published in the Journal of Banking and Finance found that "decarbonisation selling pressure" does negatively affect the stock prices of divested firms and contributes to the reduction of these firms' carbon emissions.

Finally, Mackintosh highlights the fact that most sustainable funds simply use ESG ratings to try to generate better investment returns, not to try to change the world. The reason he feels the need to point this out reflects the underlying theme of his entire argument – that sustainable investors are hopelessly naive and have been duped into thinking that they can change the world.

Active, And Not Naive

Well, thank you for your concern, but sustainable investors are far from naive. They understand better than most the urgency of making progress on major systemic problems by whatever means necessary. They understand that, as investors, they cannot behave as though problems don't exist and won't harm their long-term returns. But they also understand their investments need to generate returns that will help them reach their financial goals. A sustainable investment is an investment first, but that doesn't mean it can't generate positive impact.

One important way that sustainable investing is generating real impact is through direct shareholder engagement with companies about various ESG-related concerns and, when engagement isn't successful, voting in favour of ESG-related shareholder proposals. In the past several years, these efforts have been more successful than ever.

Indeed, this year's proxy season in the US began with 70% of Costco shareholders supporting a proposal sponsored by Green Century Funds, calling on the company to set science-based targets to reduce its greenhouse gas emissions.

Jon Hale is Morningstar's director of ESG research for the Americas and a member of Morningstar's investment research department. He has been researching the fund industry since 1995. While Morningstar typically agrees with his views, they are his own

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Jon Hale  Jon Hale is a consultant with Morningstar Institutional Investment Consulting.