Interest in responsible investment has seen an exponential growth over the past decade. Investments are pouring into ESG-based products at an accelerating rate. The trend is good, but not fully without problems.
The fact that the definitions, standards and approaches in terms of responsible or ESG investing are still fragmented increases the risk of confusion and misinformation. We are living in a kind of “ESG zoo” where we have to navigate based on deficient information. It is not wise to follow all market trends blindly as it might result in nonessential greenwashing; a phenomenon that should be avoided.
Discrepancies in ESG goals
A responsible investor may observe discrepancies between the various ESG goals. Focusing on environmental development goals might have negative impacts on social development goals, and vice versa. For example, while the use of solar panels contributes to clean energy production, their components originate from countries where the working conditions in factories are poor because of lower labour standards.
Another problematic issue in terms of responsible investing are the expectations concerning the impacts of the ESG factors on investment returns. Although several studies indicate that the ESG strategies improve the risk-return ratio of the portfolio, there are an equal number of analyses claiming that ESG investing has no positive effect on the future returns on investments. Due to the lack of sufficient statistical evidence, the implications of ESG factors on investment returns in the long term remain speculative in light of current information. Therefore, the long-term positive impacts of ESG investments are based more on counterfactual and wishful thinking than on empirical evidence.
How do we find the right direction?
To avoid confusion and discrepancies, it is advisable to begin integrating ESG investments in the portfolio by focusing on a few clearly defined and easily measurable goals. There is no sense in trying to aim at too large a portion all at once if the target is constantly changing and developing. At Veritas, we started by measuring factors related to the mitigation of climate change and reporting on them in accordance with the generally approved TCFD standard. The aim is for our portfolio to achieve carbon neutrality by 2035.
Although responsible investing has its challenges, ignoring the ESG factors is not an option for an institutional investor. Each investor should make their own path through the ESG zoo but, fortunately, we are not alone in this venture. The best outcome is often reached through collaboration, and this holds true for ESG investing as well. In collaboration with other institutional investors, we can advance the development of responsible ways of operating in the financial markets.
This blog was inspired by the interview made for the Eurex Derivatives Forum Frankfurt 2021 report. The report is available here.