SUSTAINABLE INVESTING

Response to a Sustainable Investing Antagonist

12.08.2021 - Jeff Finkelman, Vice President, Sustainable Investing

The sustainable investing market, even as it has gained steam, has long been the target of skepticism and, at times, derision. But it has most recently faced criticism from an unlikely source. Tariq Fancy, former Chief Investment Officer for Sustainable Investing at BlackRock, the world's largest asset manager, has become one of the field’s leading antagonists, having published several high-profile critiques of sustainable investing based on his disillusioning experience at that firm. The latest, an essay published on The Economist magazine website in early November, re-hashes arguments Fancy has repeated throughout the year, most extensively in an August essay titled The Secret Diary of a ‘Sustainable Investor.’ 

Predictably, the responses from other sustainable investors have been robust in countering these claims. We are among those who have fundamental disagreements with Fancy’s characterization of the sustainable investing industry, its practices, and objectives.

The Tide is Turning on Greenwashing

The main source of Fancy’s disillusionment is “greenwashing,” the practice of marketing an investment product as having positive environmental, social, or governance (ESG) attributes where none exist. His central argument is that sustainable investing is sold as the sole solution to the world’s biggest social and environmental challenges. Fancy recounts an episode in which a BlackRock executive urged him to “gloss over” the complexities of the firm’s ESG products and simply sell them to the public as a way to combat climate change.[1]

Greenwashing is a vexing issue to be sure. Just as 75% of investment managers might claim to be top quartile performers[2], sustainable investors universally condemn greenwashing, but none will admit they are guilty of it. Overuse of aphorisms like “doing well by doing good” often come across as glib and undermine the seriousness of the industry’s work. Worse, some investment management firms’ deceptive ESG claims have drawn legal scrutiny.[3]

Misleading marketing claims are hardly a new phenomenon. To dismiss the entire field of sustainable investing as ineffectual is not only an overreaction, but also treats asset owners as rubes, willing to believe whatever Wall Street’s marketing departments tell them.

Investors concerned about creating an impact with their capital are attuned to the risks of greenwashing and have mounted robust defenses to protect the integrity of the sustainable investing industry. Industry groups, from the Impact Management Project to the Global Impact Investing Network, have been focused on developing standards and promulgating best practices to ensure impact capital has an impact. These groups have made significant progress such that an impact measurement and management sub-industry has begun to emerge, offering the promise of independent, third-party verification of asset managers’ impact claims.

ESG and Performance

Fancy’s criticism is not limited to marketing claims. He has also criticized the thesis that ESG factors matter for investment performance. ESG skeptic and Financial Times columnist Robert Armstrong summarized Fancy’s argument as follows, “If ESG investing did provide higher returns … then profit-seeking investment managers would be doing all the work for us, and we wouldn’t have to be having this damn conversation in the first place.”[4]

The circular logic of this argument is reminiscent of the debate over market efficiency and the relative merits of active versus passive investment management. If you share the view that security prices already reflect all relevant information, research will not give you an edge. But if you are investing in a market where information is scarce, data is unstandardized, and analysis is difficult, conducting your own research may give you an informational advantage over other market participants.

The state of ESG investing today fits the latter profile far better than it does the former. Contrary to what Armstrong suggests, there are plenty of asset managers striving to “do the work for us” and make use of ESG data in a way that others have yet to figure out. But there are no silver bullets. With few exceptions, strategies that take a formulaic approach to ESG investing, systematically tilting a portfolio towards better ESG performers and away from poor ESG performers, may be great for achieving values alignment but are unlikely to yield substantial performance benefits. These kinds of strategies tend to rely on top-level ESG scores that not only depend on widely available, backward-looking information, but also tend to “mash” together, as Fancy rightly notes, “widely varying measurements of environmental and social performance.”[5]

In our view, ESG data and analysis typically contributes to investment performance only when it is integrated into a fundamental, bottom-up investment process. Investment analysts, deeply familiar with the industries they cover, seem best placed to make sense of a company’s carbon emissions trajectory, its susceptibility to water scarcity, or the quality of its workforce development efforts. Fiduciary Trust International’s lead equity research analyst, Alex Chown, offered several examples of this process in action in a blog post highlighting the compatibility of ESG analysis with fundamentally driven “quality” investing. In order to gain an edge from ESG, it does not need to become the purpose of an investment strategy; it simply needs to become part of the process.

A Public-Private Partnership

Though Fancy devotes most of his critique to the investment case for ESG, his ultimate point is a political one. Fancy believes sustainable investing is a “deadly distraction” being sold to an unwitting public as a market-based substitute for public policy.[6]  “There is no doubt in my mind,” Fancy writes, “that organizing politically to enact aggressive climate legislation is a better route to fighting climate change than buying a low carbon ETF.”[7]

What sustainable investor would disagree? There is healthy debate within the sustainable investing community about which investment strategies truly generate an impact and which ones are simply window dressing. But to suggest that sustainable investors are standing in the way of effective public policy on social or environmental issues flies in the face of the evidence. The net zero initiatives that have now attracted commitments from $130 trillion in managed assets all acknowledge the essential role of government and include a pledge to “advocate for the public policy needed to accelerate investment in net zero-aligned activities and organizations.”[8]  When the SEC sought public comment regarding the introduction of corporate climate change disclosure, sustainable investors submitted hundreds of letters expressing support.[9]  After all, investors betting on humanity’s ability to build a more just and sustainable future are among those most likely to profit from aggressive government action.

Sustainable Investing Has Reached an Inflection Point

Sustainable investing is a fast-growing field of finance and deserves close scrutiny. But now is not the time to slow down. Public trust in government is near historic lows and massive capital gaps stand in the way of achieving a broad range of social and environmental objectives.[10]  Combatting climate change will require $4 trillion in annual clean energy investments[11]. Small-and-medium enterprises in low- and middle-income countries face a $5 trillion credit gap[12]. In 2020, just over 2% of venture capital funding went to Black and Latino founders [13] . Sustainable investing cannot solve all these problems, but it is a key tool to leverage in resolving some of the most critical challenges of our era.

 

[1] The Secret Diary of a Sustainable Investor - Tariq Fancy.pdf (dropbox.com), pg. 3

[2] Study: 77% of GPs could claim top quartile status | Private Equity International

[3] U.S. Authorities Probing Deutsche Bank’s DWS Over Sustainability Claims - WSJ

[4] The ESG investing industry is dangerous | Financial Times (ft.com)

[5] The Secret Diary of a Sustainable Investor - Tariq Fancy.pdf (dropbox.com), pg. 12

[6] Ibid, pg. 26

[7] Ibid, pg. 38

[8] About | Glasgow Financial Alliance for Net Zero (gfanzero.com)

[9] SEC.gov | Comments on Climate Change Disclosures

[10] Public Trust in Government: 1958-2021 | Pew Research Center

[11] Net Zero by 2050 – Analysis - IEA

[12] MSME Finance Gap | SME Finance Forum

[13] VC Pledged to 'Do Better' on Diversity. It's Barely Changed | WIRED




This communication is intended solely to provide general information. The information and opinions stated may change without notice. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.

IRS Circular 230 Notice: Pursuant to relevant U.S. Treasury regulations, we inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. You should seek advice based on your particular circumstances from your tax advisor.

CFA® and Chartered Financial Analyst® are trademarks owned by CFA institute.

SUSTAINABLE INVESTING

The Next Chapter in Sustainable Investing: The Private Sector Tightens Its Focus on Climate Change

01.03.2022 Jeff Finkelman, Managing Director, Sustainable Investing

The Next Chapter in Sustainable Investing: The Private Sector Tightens Its Focus on Climate ChangeNEXT POST

SUSTAINABLE INVESTING

Developing a Sustainable Food System in the United States

10.20.2021

Developing a Sustainable Food System in the United StatesPREVIOUS POST