Split ESG in Two? Not Like This....

9/5/22 9:22 AM

Stuart Kirk has strong opinions. An ex editor of the Financial Times Lex column, Mr. Kirk moved on to become head of Responsible Investment at HSBC Asset Management. In that role he made an infamous speech in July 2022 at the FT's Moral Money conference. In a presentation entitled "why investors need not worry about climate risk" Kirk provided various words of wisdom, noting that throughout his 25-year career in the finance industry “there was always some nut job telling me about the end of the world”. In a new article in the Financial Times, Kirk - whose career at HSBS came to a rapid halt - argues that "ESG Must Be Split in Two: If We Do Not Disentangle The Industry's Dual Meanings, It Will Not Progress". The article is both insightful and disheartening.

Kirk's article argues that there are two sides to ESG. The first is to consider ESG inputs in the investment decision making process. As Kirk's article notes:

[This] "is how portfolio managers, analysts and data companies have understood ESG investing for years. That is: “taking environmental, social and governance issues into account when trying to assess the potential risk-adjusted returns of an asset.” Most funds are ESG on this basis. Weather, corporate culture or poor governance always influence valuations to some degree."

To Kirk (and apparently everyone who works or has ever worked in the investment industry) E, S and G are factors which portfolio managers consider as they evaluate whether a stock (or other potential investment) is underpriced or overpriced and is therefore likely to be profitable or not. However, E, S and G are just three factors among many (tens, hundreds, thousands?) which support a valuation model, with the result that:

"In an ESG-input world, for example, it is OK to own a polluting Japanese manufacturer with terrible governance if these risks are considered less material than other drivers of returns" or "After a huge sell-off in stocks with bad ESG ratings, you probably want loads of them if they’re cheap enough."

In other words, oh-so-wise investment professionals will think about ESG to help them determine if a stock is under- or over-valued. To Kirk, integrating ESG as an input to the investment decision making process (and presumably stating that in your marketing materials) is entirely compatible with investing in a company with toxic environmental activities and horrendous social characteristics - as long as the stock is cheap enough.


The second approach to ESG is to consider ESG Outputs. Kirk states this means "investing in 'ethical', 'green' or 'sustainable' assets. And this second meaning is how most people think of ESG - trying to do the right thing with their money. They prefer a company that doesn't burn coal, eschews nepotism and has diverse senior executives".


What is fascinating here is to see a senior investment professional apparently befuddled that investors looking at ESG are focused on outputs - where does their money end up, and what is the impact of their money in E, S and G terms. Shouldn't investors just trust those wise investment professionals who have "scored" ESG when building their portfolio, having judged that profits in some stocks are high enough to outweigh pesky E, S or G criteria?

If we are still in a world where investment staff still believe that ESG has "carried two meanings from birth" (as Kirk states in his article), we have further to go in our ESG journey than perhaps we realise. But if investment professionals still don't "get it" (still!) we at least know where to target more of our ESG efforts as we engage with asset managers to do a better job on allocators' behalf.




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