One of the biggest misconceptions about ESG investing is that it’s a type of asset class. That is, an investor picks stocks according to scores determined by environmental, social and governance criteria.
As Michael Young, director of education and outreach at the Sustainable Investment Forum, or US SIF, explains, that is fundamentally untrue.
“Professional investors and people who really know what ESG data is, know it isn’t political,” he told me in an interview, below. “It’s literally just data. How it’s used is going to be so different by organization and professional investor type or by individuals for certain values they want to achieve.”
US SIF is the largest nonprofit organization for the sustainable and impact investment sectors in the U.S. Member companies oversee $5 trillion in assets under management or advisement.
I spoke with Young about potential ESG policies to be implemented this year, why ESG data are useful to even investment managers who are anti-ESG, and ESG used as political football.
Chuck Jaffe: ESG is, for some people, a primary focus of their investments while, for others, it is a secondary. When we’re usually talking about the stock market, we’re not necessarily talking about ESG (environmental, social and governance).
Let’s start with something that happened last year, a global sustainable investment review. There was a lot to come out of it in terms of suggestions, but this is the year when we’re going to see some of those become the focus, right? So help us understand that.
Michael Young: That report was published in mid-November. The total assets under management across the globe in sustainable investments was just a little over $30 trillion. When we look at that number and break it down here in the U.S., it comes out to about $8.5 trillion.
Because ESG was, first of all, a political target, we had hearings on the Hill, but we saw a lot of policy advancements. So these are the sort of things that we should keep our eyes on as we head into the middle of 2024. And we’ll see where things go in election season.
But a couple of things to highlight from 2023: There was a Congressional Sustainable Investment Caucus formed in January. So, actually, members of the House — it’s a bipartisan caucus to inform other colleagues of what actually is used by investment managers and professional investors when they’re considering ESG — we saw the Climate Risk Disclosure Act, which was passed in 2021, lead to some SEC (Securities and Exchange Commission) proposals last year. And we may see some of those go final here in 2024.
One in particular is related to climate disclosure. So depending on what this final rule looks like, we may see that the SEC puts out a mandated reporting requirement for Scope One and Two emissions and potentially Scope Three. If this would become a final rule in 2024, the reason this is of interest to not just ESG investors, but to anybody that’s considering ESG, whether it’s primary or secondary, is it would be the first standard in the U.S. for climate or social criteria reported by corporations and mandated.
From that perspective, it would be really big. We did see California, which has long been a leader on a state level for things like auto emissions, they actually passed a climate disclosure law. We’ll see how that stands up in court. But when it was signed into law, it actually required disclosure of (scopes) one, two and three emissions for all companies doing business in California. And as happened with car emissions, often what happens in that state becomes the de facto national standard, if and until the SEC would come up with a final rule.
So with all that said, this is going to be a very interesting year from a policy standpoint here in the U.S. and could be a driver for adoption of more sustainable investment practices by institutional managers. And then the interest that we’ve seen from individuals remains very strong. So we’re keeping an eye on that.
CJ: In terms of ESG itself, one of the reasons that Congress was looking at it is it has become a blanket term that is hard to define. I’ll see ESG investing that is very much aligned with someone’s values. In other words, whether it’s your religious beliefs or it’s your social preferences. And then I’ll see ESG investing that is a way to run a business, but we’re not investing with any beliefs whatsoever. In other words, you’ll talk to a money manager and it’s like, ‘We just believe that better governance is better results.’
How much does that kind of thing need to be defined and refined so that investors truly understand what they are getting with ESG?
MY: That’s a great question and a great point. The use of ESG is so different. Ultimately, anyone that works in sustainable investment, whether it’s as a primary focus, as you said, is values-driven.
They want data — they want financially material data — from companies so they can make their decisions about whether they want to hold them in a portfolio and to what weighting, whether that’s a fund or a pension or any sort of asset owners. And the other possibility is that it’s just sort of a secondary item that is used by a traditional manager, but again, gives insight on the corporation that you might not see in traditional financial line items. So it’s really important from an education standpoint to remember that.
For professional investors, there’s a lot of resources. The CFA Institute released an ESG certificate. So for those that are managing portfolios that want to become experts in what these financially material data points might be and how to use those criteria in investment decision-making, that’s out there. For financial advisers, there is a professional designation offered by the College for Financial Planning. Full disclosure, USCF helps with the curriculum.
As we look at the U.S. markets and think about what themes are driving corporations adopting sustainable practices that turn into ESG data points that are under consideration, you’re exactly right. There are certainly considerations as people are looking at net-zero target dates. Corporations are definitely aware of what governments are looking at achieving and making sure they’re aligned with that. But additionally, as you said, professional investors care about corporate governance, share structures, ownership, board independence. These are things that can really impact how a company is run.
CJ: We have an election year and ESG is a political football. Is there anything that ESG proponents can, should, are doing that is going to somehow make it that ESG doesn’t come through this election cycle stigmatized because there was a little bit of that starting last year.
MY: A hundred percent. So the most important thing to take from what happened last year is that professional investors and people who really know what ESG data is, know it isn’t political. It’s literally just data. How it’s used is going to be so different by organization and professional investor type or by individuals for certain values they want to achieve.
We should hammer home — those of us that are proponents for the use of ESG data, or at least the availability of ESG data — on what the argument was last year. So for every organization or state or federal suggestion that they were anti-ESG, what they were really saying is they wanted to limit what financial material could be released. And so we saw this to the detriment of some states that removed funds that considered ESG data in their financial material.
CJ: We should point out, to use the vernacular, that what we’re really talking about is that folks are saying, ‘Oh, I don’t want my investments to be woke.’
MY: That’s exactly right. And I think this is one of the big challenges of when it’s framed by politicians that don’t understand financial services, let alone something like data. ESG is just data. It’s used by anyone, right? You can’t launch an anti-woke fund without the data. You still need the ESG data to figure out what you’re screening out and what you’re screening in if that’s your goal. But absolutely, there are climate-focused investors that need more “E.” There are plenty of religious-values investors that need the ESG data to help them dive deeper into a corporation to make sure that they’re not getting exposure to something that is against their tenets or values that they are looking to avoid.
So it’s really important that people understand that the framework that sometimes ESG is brought up in is brought up by people who don’t understand it at all. And for serious investors or for people that are thinking about it, no matter what side of the issue you might be on; if you wanted to be an all-fossil-fuel fund or you wanted to exclude all fossil fuels, you still need the ESG data to build your portfolio.
I think that’s really important. And some of the attacks last year were essentially to prohibit the use of ESG data. And some funds were even removed from state pension plans for those that were making sort of a political statement, not a financially wise move. But the end result is we, as proponents for sustainable investing, think ultimately we just want free access, free market. We want freedom to make our own decisions, but we want the information to be available to us.
And that’s really what we’re pushing for with things like disclosure requirements. We want that information available to investors so we can make better decisions. And understand what ESG is and how it applies to you. If you want to invest in line with your values, there are ways to do it.
Chuck Jaffe is a contributor at Equities and the host of “Money Life.”