Why it's crucial to consider long-term perspective inherent in ESG investing

A few months ago, valuation expert Ashwath Damodaran asserted that ESG is a failure and should be retired. His argument was based on the distinct metrics for environment, social and governance, claiming that they serve different needs. He's right, they do. But therein lies the intent of ESG, acknowledging the multifaceted nature of businesses and the complex web of ESG factors that impact their operations.

Damodaran blamed the inclusion of 'S' in ESG, citing the impossibility of achieving consensus on social issues. While consensus may be elusive, ESG doesn't aim for a one-size-fits-all definition of 'good' or 'bad' companies.

His concern that companies will manipulate ESG scoring systems to their advantage is valid. But then, it should not deter us from placing faith in ESG principles or continuously enhancing the ESG framework. In the financial world, when we encounter problems or crises, we don't discard our regulations. Instead, we focus on refining and strengthening those, bolstering supervision and adapting to the changing landscape. The key lies in what is measured and how it is measured - constantly evolving and improving ESG assessment methodologies is essential to ensure they are reliable, robust and resistant to manipulation.

While Damodaran expressed deep distrust in CEOs, it's essential to recognise that the corporate sector plays a pivotal role. Trust issues about CEOs need to be addressed through regulatory measures like granular disclosures and enhanced transparency within corporate frameworks. This is precisely where ESG has a role to play. The choice to advocate for trusting governments over corporate leaders is personal, but addressing the world's most pressing challenges demands a collaborative approach. Blanket distrust of the corporate world overlooks the potential for corporations to evolve and contribute positively to societal progress.

It is important to accept that ESG investments are far from a homogenous asset class. They encompass a broad spectrum of companies and strategies. The performance of ESG investments can exhibit significant variations due to several factors.

• Specific ESG criteria employed.

• Markets in which such criteria are assessed or applied.

• Potential for regulatory arbitrage in these markets.

• Investment time horizon, and the overall depth of the market.

The prominent argument against ESG investments revolves around their purported underperformance compared to traditional investments. Critics frequently mention that ESG-focused funds or indices lag behind their non-ESG counterparts.

While this assertion may hold true in many cases, it's crucial to consider the long-term perspective inherent in ESG investing. Short-term underperformance should not eclipse the potential for ESG investments to yield robust returns over more extended periods. Furthermore, it's vital to acknowledge that the ESG landscape is in a constant state of evolution. Regulatory shifts, industry transformations and heightened awareness of ESG factors contribute to the prospect of enhanced ESG performance. While hope cannot be a strategy, regulatory 'carrot and stick' could nudge forward movement in the ESG journey.

On a global scale, financial and market regulators confront a compelling imperative: establishing a consensus on a global minimum standard for the ESG framework. In an interconnected world, where capital flows seamlessly across borders, a standardised and homogenised approach ensures that investors can access consistent and reliable information for informed decision-making. This would maintain that ESG data remains trustworthy and assessments remain credible, regardless of a company's geographic location or industry.

Criticism and resistance to inventions and innovations have been recurring themes throughout history. The automobile was initially derided as noisy and unreliable, with some critics even suggesting that it wouldn't replace the horse and carriage. Aircraft faced scepticism, with some believing it was an unattainable dream. In the financial world, the introduction of credit cards was met with scepticism when it was introduced in the mid-20th century. People questioned the security and practicality of using a piece of plastic for transactions. Likewise, the concept of securitisation faced doubts in its early days, but it has since become a cornerstone of modern finance.

A growing number of businesses are poised to embrace the net-positive concept. Nations, too, are diligently striving toward the ambitious net-zero 2050 goal. The convergence of cutting-edge technologies, robust regulatory initiatives and compelling cost advantages will push the ESG journey. In corporate boards, this will find its rightful place on the quarterly agenda.

Companies are not merely obligated to showcase exemplary conduct to their clientele. They must commit to encompass all stakeholders, including their employees. That's where goodness in ideology and action will count. No framework - however noble its goals - can be expected to deliver perfection from day one.