Is ESG investing contributing to transitioning to a sustainable economy or to the greatest misallocations of capital and a missed opportunity?

Abstract

Environmental, Social and Governance (ESG) investing has become a focus not only of the asset management industry but also among policy makers as a way to mobilise capital for sustainable economic development. While this could be the mechanism through which capital is allocated to companies and technology of the future to help transition to a net-zero sustainable economy and to deliver on the UN SDGs, all of the ‘noise’ around ESG reporting coupled with the ESG ‘investing frenzy’ may more likely end up being the greatest misallocation of capital and a missed opportunity. Asset owners’ strong interest in investing in ‘green’ assets to transition to a net-zero sustainable economy has led to a growing trend of asset managers labelling and rebranding mutual funds and ETFs as ESG and even mainstream funds are advertising employing ‘ESG integration’. At the same time, significant ‘greenwashing’ exits at the company reporting level due to the lack of agreed standards. Moreover, poor correlations across ESG score providers for a given company as well as intentional built-in biases introduced into the scoring and the total lack of any analysis taking into account ecological ceilings, sustainability thresholds and outer boundary limits of natural resources, will all likely lead to material capital allocation distortions. ‘Greenwashing’ at both the asset manager and the corporate level and the resultant misallocation of capital is likely setting the stage for potential risks including significant macroeconomic and geopolitical risks, as well as risks to the financial markets and financial institutions.