At the beginning of this year, the FINRA Investor Education Fund surveyed 1200+ investors, and asked them these two questions:
- Can you define ESG?
2. What do the E, S, and G stand for?
Surprisingly, only 24% of the 1,228 investors surveyed could correctly define ESG investing, and just 21% knew what the letters in ESG stood for.
It’s strikingly odd that, at least according to this study, one of the most prolific social and financial frameworks in recent years is so misunderstood. We can’t help but wonder…why??
The purpose of opening with this citation is not at all to shame anyone, but rather because we think when trying to create impact and change, it’s important to first face reality. In this case, the reality is: we’re not all on the same page about ESG.
Let me explain.
The science and data of ESG, the public discourse around the interpretation of that data and its implementation, and accessible ESG education, or lack thereof – all three of these spheres exist very far apart from each other, with a lot of importance lost in the fray. Throw in the fact that ESG is a less than 20 year old framweork, it’s been one of the most popular investing trends during the past two decades, and, for better or worse, it is heavily platformed by politicians the world over. You can start to understand the confusion.
Google Search data for “ESG” since 2004.
Think of ESG like you think of your favorite child star: it is barely emerging from adolescence, it has become wildly popular in an extremely short amount of time, everyone is constantly talking about it, but with varying degrees of reliable information, and it is surrounded by people with ulterior motives.
And that’s okay – anything with real potential for impact and change comes with good, bad, and ugly.
Obviously, we can’t fix all of the problems around understanding ESG today, nor do we need to. But, we know we can bring a few key points of understanding closer together, and present some fresh perspective.
Today, we’ll start with breaking ESG down, examining why each ingredient that makes it up is unique, learning why it is okay that it matters differently to different investors, and ultimately understanding why it is much more impactful with individuality and nuance than as a broad stroking financial buzzword.
So stick around, we bet you’ll learn something! And we can promise you’ll become a more informed and conscious investor for reading.
Spoiler alert: ESG stands for Environmental, Social, Governance
Okay, good we’re all on the same page. Moving on!
Well, no, wait a second. What do those words even mean? We get that ESG is an acronym, but the words that make it up are broad, complex, and ambiguous concepts. They deserve a deeper dive.
The CFA Institute has a helpful table on their website, where they define the bare bones of ESG:
Environmental – Conservation of the natural world. The ‘E’ includes topics such as:
- Climate change and carbon emissions
- Air and water pollution
- Energy efficiency
- Waste management
- Water scarcity
Social – Consideration of people and relationships. The ‘S’ considers:
- Customer satisfaction
- Data protection and privacy
- Gender and diversity
- Employee engagement
- Community relations
- Human rights
- Labor standards
Governance – Standards for running a company. Perhaps the most confusing, the ‘G’ looks at:
- Board composition
- Audit committee structure
- Bribery and corruption
- Executive compensation
- Political contributions
- Whistleblower schemes
Okay so it’s clear there is a LOT packed into each E, S, and G. The reason for that is: the original intent of the ESG framework was to create a holistic picture of non-financial risk in companies. The financial industry wanted to determine a way to categorize and analyze the parts and practices of firms that had potential to create or destroy value notwithstanding their financial performance.
For investment analysis purposes, it’s nice to have everything listed out and categorized. However, through any other lens, it doesn’t make sense to cobble all these issues and topics together and apply them with one broad sweep. This is where it starts to break down.
ESG or E, S, and G?
One thing we can all admit: E gets a lot of the attention.
Clearly the golden child of the acronym family, some, when they talk about ESG, aren’t actually including social and governance at all. It definitely seems that S and G are constantly overshadowed, or individual topics within them are cherry-picked in political and public discourse.
Let’s put this assumption to the test with an example.
Off the top of your head, which company would you say is more “ESG friendly”: Tesla or GM?
I know I would have said Tesla without a second thought.
Well, Tesla is groundbreakingly environmentally friendly among the automotive industry. They’re a new, innovative company, and therefore can logically be assumed progressive. And contrasted with an old-guard automotive brand like GM, at first glance there would be no reason to doubt Tesla.
It turns out, the story isn’t that simple. Let’s consult with Daizy to help us out!
The first thing that’s important is, like I said, many people seem to naturally over-associate ESG with environment. Because Tesla is environmentally innovative and progressive, it is a totally logical conclusion without any additional information to assume Tesla is more “ESG friendly.”
If you look at all three categories though, you’ll see that where Tesla leads the way in environment, the company has a lot to improve on in social and governance.
GM actually has better social and governance scores than Tesla – although GM’s social score is still far below average. GM has a female CEO, 50% of the company’s board is women, and they are publicly committed to making all electric vehicles by 2035 and to be carbon neutral by 2040.
This doesn’t mean we were wrong, or that GM is “better” than Tesla, but it clearly illustrates that ESG is nuanced. It’s not a gold star or trophy that some companies get to brandish while others ignore or get left out.
It’s more complex than that. Companies can be pioneers in environment or governance, but be terrible with social issues. Even within categories, for instance, companies can hyperfocused on data protection and satisfaction for customers, but treat their employees terribly.
In some industries, it makes sense to weigh one ESG category, topic, or set of topics, more heavily than the others. For instance, energy companies by nature negatively impact the environment, so maybe they can have a greater positive impact by shifting their focus heavily toward ethical leadership and human rights.
Timing is also important to consider. Maybe a company has a terrible track record but has made recent changes that have led to massive improvements, despite still being behind the standards of its competitors. Maybe a company prides itself on an ESG progressive brand and invests tons into Marketing and PR, but behind the scenes, they’re not actually investing the dollars that make real impact.
The point is, it’s often better to separate and contextualize each E, S, and G, and consider them on their own merit, within each industry and company. Just because the framework groups E, S, and G together, that’s not always the most helpful perspective. Every firm has its strengths and weaknesses, priorities, and timeline. It takes digging a bit deeper to paint the full picture.
E, S, G, and U
By “U”, we mean YOU!
The best part of understanding the nuance of ESG is that it opens an entire world of ways to interact as individual investors with it!
Instead of being for, against, or neutral about ESG, you can focus on the topics that align with your values.
Instead of being an “ESG expert”, you can be an expert on your passions. Maybe your passion is human rights, maybe it’s gender equality, maybe it’s fighting leadership corruption, or maybe it’s all three. We now know that your contribution to ESG is just as needed, and just as valuable, even if you know nothing about climate change or deforestation.
At Daizy, our hope is to open doors to digestible data and information for everyone, so we can each make the most educated and conscious investing decisions. We hope those decisions are uniquely you – enacting your personality, passions, identity, and values. We don’t have to be on the same page about ESG, because our individual understandings and unique contributions will create far greater impact.