The U.S. sustainable-investment industry is moving to calm investors following a storm of criticism that arose with accusations of greenwashing and lately has been stoked by former Vice President Mike Pence, who claimed in a Wall Street Journal essay that environmental, social, and governance investing is empowering a “cabal” of CEOs, bureaucrats, and regulators to promote “left-wing values.”
The efforts to reassure investors include stressing that it is business as usual and that sustainable approaches are a valuable cornerstone of long-term investing.
Because much of the contention from sustainable-investment critics rests on the confusion of terminology, the effort centers on identifying and clarifying greenwashing as well as explaining the wide array of approaches that sustainable investing encompasses. One popular variant, ESG investing, aims to reduce risks from ESG factors. Many are also investing around their values, which sometimes involve hot-button issues such as abortion rights and gun control, and seeking particular outcomes from their investments. For example, they may want their portfolios to help achieve the U.N. Sustainable Development Goals. (For a fuller description of the general varieties of sustainable investing, see the Morningstar Sustainable-Investing Framework.) Another source of confusion is the growing popularity of stakeholder capitalism among corporations, in which employees, suppliers, customers, communities, and the environment are given equal consideration to shareholders. While this is related to sustainable investing, it is entirely separate.
In a forthcoming message to investors in the funds of Parnassus Investments, a prominent sustainable-investing firm, CEO Ben Allen wrote, “You may have seen recent commentary in the news questioning the value and authenticity of ESG investing.” Allen stressed Parnassus’ belief that investors could be financially successful while choosing to avoid companies that harm people and planet. Moreover, Allen wrote that ESG investing is hardly political: “ESG investing does certainly have a values component, but it is not a political tool of the left, and Parnassus does not have a political agenda. We simply don’t want to profit from certain companies or industries that are not aligned with our values.”
One criticism has centered on the array of sustainability ratings providers, such as Morningstar Sustainalytics or MSCI. Many sustainability ratings often don’t agree with each other. Still, Allen noted, the agencies are creating standards to bolster the consistency and accuracy of ESG evaluations for investors. And ESG factors are identifying real risks.
In an email Monday, Morningstar CEO Kunal Kapoor said, “Sustainability is redefining how investors think about risk and reward. That’s an investing conversation, not a political one. Investors increasingly want both sides of ESG: to mitigate risk and to make a difference in the world. These are not the same, and they come with a new set of trade-offs for investors to make.”
Kapoor continued that ESG critics “miss the opportunity to reframe sustainability as investability.”
Sustainable investing, Kapoor argues, is an element of what he calls active personalization, which is a growing trend in investing.
This week, BlackRock (BLK), the world’s largest investment firm, and lately a punching bag for sustainable-investment critics, unveiled an advertising campaign to emphasize how it helps investors prepare for retirement, even as Republicans criticize it for pushing a “radical ESG agenda” and some states threaten to limit how much business they do with it. The firm and its outspoken CEO Larry Fink have faced scrutiny for its stance on climate change. BlackRock is a dual target: as a provider of sustainable-investment funds, with billions of client dollars committed to the strategy; and as a company that has espoused stakeholder capitalism to client companies. He views stakeholder capitalism as critical to companies’ long-term future, so that they can “evolve and grow so that they generate attractive returns for decades to come,” as Fink wrote earlier this year.
“Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not ‘woke,’” Fink wrote. “It is through effective stakeholder capitalism that capital is efficiently allocated, companies achieve durable profitability, and value is created and sustained over the long term. Make no mistake, the fair pursuit of profit is still what animates markets; and long-term profitability is the measure by which markets will ultimately determine your company’s success.”
Other defenses of stakeholder capitalism have emerged. JPMorgan Chase (JPM) CEO Jamie Dimon, who supported stakeholder capitalism as chair of the Business Roundtable, said at a recent conference that stakeholder capitalism isn’t “woke” and described himself as “a red-blooded free-market capitalist.”
“All we’re saying is when we wake up in the morning, what we give a shit about is serving customers, earning their respect, earning their repeat business,” Dimon said, according to the Financial Times.
Pence’s editorial “was a repudiation of the entire stakeholder idea,” wrote Martin Whittaker, CEO of Just Capital, a nonprofit that surveys consumers on what attributes they want to see from companies and is also a proponent of stakeholder capitalism.
“Paying people fairly, creating good jobs in the U.S., investing in communities, respecting customers, embracing moral leadership, advancing accountability—based on seven years of polling, these are the things that constitute good business, not adherence to political dogma,” Whittaker wrote.
Indeed, proponents of ESG investing have said in the past that it is necessary to investing and capitalism. In an interview at the COP26 climate meeting in 2021, MSCI CEO Henry Fernandez said ESG is “100% a defense of the free-enterprise, capitalistic system and has nothing to do with, you know, socialism or zealousness or any of that.”
There is plenty of room for misunderstanding because sustainable-investing contains a wide range of approaches. The Morningstar framework identifies six main ways that investors practice sustainable investing: Applying exclusions, limiting ESG risk, seeking ESG opportunities, practicing active ownership, targeting sustainability themes, and assessing impact.
One of the reasons people have grown concerned about greenwashing is the use of “ESG integration” (what we at Morningstar call limiting ESG risk), in which companies use ESG factors in investing, but no more so than other factors such as earnings growth. Indeed, the SEC is proposing to enhance and standardize current practice so that such funds describe to investors how central the ESG process is.
At the annual conference of U.S. SIF, the sustainability industry trade organization, participants pledged to redouble their efforts to root out greenwashing and clarify terms. “If you aren’t transparent and accountable about the use of ESG criteria across portfolios, that’s wrong,” CEO Lisa Woll said at the conference Monday.
Ivy Jack, head of equity research for NorthStar Asset Management, said that despite the criticisms, the firm’s clients remain interested in investing their values, particularly in the wake of economic turmoil caused by the pandemic. However, they are more concerned about the market’s decline. Jack and her colleagues are advising them that “it’s time to lean more into your values” as long-term investors.
Speaking at the conference on Monday, Jon Hale, head of U.S. sustainability research at Morningstar, said, “We need to keep in mind first and foremost that these attacks are evidence of the field’s success and not failure.”
Hale also said that sustainable investing was not a political activity but an investment practice. He further stated that mutual funds with a sustainability focus do need to be more transparent about what they do. The SEC’s new disclosure rules will help. But already, funds are beginning to expand their reporting and disclosure to better explain what they do. Today’s criticisms will only hasten this trend.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.