Editor's Note: This article first appeared in the Q3 2022 issue of Morningstar magazine. Jon Hale, Ph.D., CFA, is a member of the editorial board of Morningstar magazine.
What should we call investing that supports the transition to a just, low-carbon economy and encourages companies to focus on creating sustainable value for all stakeholders, including positive impacts on people and planet?
While it’s not perfect, I prefer the term sustainable investing, but it’s a battle I may not be winning. Many seem to prefer the simple initialism for environmental, social, and governance-based investing: ESG. It’s a convenient shorthand, for sure, and one that I’m not above using myself: I maintain a blog on Medium called The ESG Advisor. And for headline writers, sustainable investing takes up 7 times more space than ESG. That could be one reason ESG is used more often in fund names. In the United States, I count 151 funds with ESG in their names as opposed to 123 with some version of sustainable.
But I think the real reason so many asset managers and intermediaries (consultants, wealth managers, advisors) use ESG is because it sounds more values-neutral, gives them flexibility in interpreting how they practice this type of investing, and allows them to sidestep the bigger-picture theory of change that sustainable investing implies. Many (perhaps most) traditional investment professionals are uncomfortable with, if not outright hostile toward, the broader project of encouraging companies to embed sustainability into their operations and business models to create value for all stakeholders.
Using ESG gives them cover to define what they’re doing far more narrowly. Many asset managers simply claim to be using ESG metrics—when they believe them to be material—to inform their investment decisions. It’s all in the shrug of the shoulders: “Sure, we consider ESG data on the chance that it might provide some insight to our investment decisions. Why not?”
The widespread use of ESG obscures the broader purpose of sustainable investing, makes it easier for opponents to attack, and makes it harder for investors who are interested in it to put their intentions into action.
Preserving the Intention-Action Gap
Many investors are interested in sustainable investing, but as is often the case with sustainable products generally, there’s a gap between intentions and action. For sustainable-investing products, the gap is wide because of the very nature of investing. While many are attracted to the concept, they make actual investment decisions only periodically, based on episodic life events like starting a new job, having a child, receiving an inheritance, or retiring. But the use of ESG terminology isn’t helping reduce the intention-action gap.
In a recent survey conducted by NORC for the Finra Investor Education Foundation, retail investors indicated strong support conceptually for sustainable investing. More than half of respondents (57%) agreed that investing can be a way to make positive change in the world, and only 37% agreed that a company should focus on maximizing earnings and not pursue social or environmental goals.
Yet only one in four respondents could correctly define ESG, and only one in five could say what ESG stands for. Not surprisingly, only 9% said they hold ESG investments, 4 times fewer than those who do not even know whether they own ESG investments.
By using the nonintuitive descriptor ESG, we are making it harder for investors to put their intentions into action.
Providing Fodder for Opponents
An ill-defined concept is vulnerable to attacks and caricatures from opponents. This happens in politics all the time. When an appealing candidate or new idea emerges, opponents try to move quickly to define them in negative terms before they can fully define themselves.
That’s happening today both inside and outside the investment world. The worst examples inside the investment world are based on the straw-man assumption that ESG investing simply sorts companies into “good” and “bad” based on questionable metrics, then invests only in the good without any further financial or valuation considerations. Such a naive approach, they claim, is doomed to underperform and distracts companies from focusing on maximizing shareholder profits.
Much more troubling is the growing animosity toward ESG on the political right in the United States. In its telling, ESG is just one more front in the anti-American progressive takeover of the country. Former Vice President Mike Pence came out swinging in a speech in Texas in May 2022, saying that “capricious new ESG regulations” are allowing “left-wing radicals to destroy American energy producers from within.”
Fresh off its success in vilifying critical race theory, the political right is trying to give the same treatment to ESG. With critical race theory, the right took a not widely understood academic concept, defined it as radical, and used it to vilify something that had been widely supported: the idea that students need to better understand the legacy of slavery and racism in the U.S.
Now, the political right is taking the concept of ESG, which is also not widely understood, and using it to vilify something that is also widely supported: the idea that companies should focus on creating value for all stakeholders, address a diverse employee base, and take steps to alleviate the climate crisis.
To underscore that point, Just Capital released poll results in May showing that more than 80% of Americans believe corporations should alleviate the pay gap between CEOs and median workers and pay a living wage to all its employees. Earlier polling from Just Capital found that 75% believe corporations should “make changes to ensure all aspects of their business are environmentally sustainable.”
Narrowing the Scope of Action for Companies
Use of the term ESG rather than sustainability seems to be getting more popular in the corporate world, as well. Writing in the MIT Sloan Management Review, Andrew Winston recently noted the increased use of ESG terminology by companies and linked it to “the investment community’s arrival on the sustainability scene, at long last.”
Unfortunately, Winston argues, the use of ESG may reduce corporate perceptions of the scope of action needed to embed sustainability into their businesses. It may lead companies to think of their sustainability challenges more narrowly in terms of addressing a set of specific ESG issues while discouraging broader thinking about how to shift to a stakeholder model and define purpose beyond maximizing shareholder returns.
Is the Glass Really Half Empty?
Winston does acknowledge that the glass may be half full rather than half empty. Terminology aside, it’s a good thing for companies to know that investors are now “on the scene” alongside employees, customers, and citizens. I concur. This grand coalition is encouraging companies to address their sustainability challenges and embed sustainability thinking into their businesses. But this is a reminder that words matter, and using the term ESG rather than sustainability may be obscuring more than it is clarifying. And that, in turn, may lead to less substantial outcomes than the world needs right now.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.