Question of the Day: ESG & Exclusion

Here’s a question we hear occasionally from investors who are just getting started with ESG.

Q: Doesn’t investing with ESG imply the elimination of companies from your starting universe?

A: Au contraire.

The majority of professional investors know that ESG is not an investment strategy. Straight up, it’s data and information that investors can use to pursue a vast array of financial and/or ethical goals. The misunderstanding that ESG implies the elimination of companies with lower scores echoes widespread confusion about common terms in the “socially responsible investing” (SRI) ecosystem. Let’s sort it out real quick.

Guilt by association?

It’s true that the term ESG is often mentioned in association with “socially responsible,” “responsible,” “sustainable,” “conscious,” or “impact” investment; some of these strategies sometimes eliminate companies based on moral grounds or for low ESG scores.

Because ESG is mentioned prominently in this context, some observers don’t see where ESG really fits into the equation. Inevitably, some may come to mix up the strategies themselves with poor, innocent ESG.

Even Chief Investment Officer editor Nick Reeves fell into this trap. In an article about ESG’s image problem, he writes, “There is an alphabet soup of acronyms for what is essentially the same thing. We have ESG, SRI (socially responsible investing), and CSR (corporate social responsibility)… impact investing, screening (positive or negative), and the worst one, ‘responsible investing’—the ESG world’s equivalent of ‘solutions.’”

Quotes like this just add to the confusion. As Blue & Green Tomorrow explains, “Part of the problem is that many of the acronyms and expressions used lack an agreed upon definition, and are often used casually or interchangeably.”

The Christian Science Monitor agrees. “If you decide to align your portfolio with your ideals, be prepared for a rapid slide into a swamp of murky jargon…Sorting out this alphabet soup can be daunting, because the terms are related.”

That metaphor “alphabet soup” is a rash in reporting about ESG, SRI, CSR, and so on. But the problem is real. The acronyms, and the very words they stand for, are all open to wide degrees of interpretation.

“Socially Responsible” — one size fits all?

Let’s look at socially responsible investing for example. At its core, the field of investing was founded on the idea of choosing investments based on their ethical or moral value to the investor. But every investor is different. Every person maintains their own concept of what is moral or ethical, based on values they’ve learned, adopted, and adapted throughout life from family, teachers, churches, friends, media, and so on.

This inherent subjectivity is even reflected in the numerous definitions Google turns up, with lots to compare and contrast. Check these out:

Wikipedia: Socially responsible investing (SRI), or Social investment, also known as sustainable, socially conscious, “green” or ethical investing, is any investment strategy which seeks to consider both financial return and social good to bring about social change.” [The entry adds that socially responsible investing can be implemented in various specific ways but can broadly cover many approaches.]

Investopedia: An investment is considered socially responsible because of the nature of the business the company conducts. Common themes for socially responsible investments include avoiding investment in companies that produce or sell addictive substances (like alcohol, gambling and tobacco) and seeking out companies engaged in social justice, environmental sustainability and alternative energy/clean technology efforts.

And still, both The Forum for Sustainable and Responsible Investment (US SIF) and the Principles for Responsible Investment (the PRI) agree that responsible investing means evaluating ESG factors.
If the very definitional foundations of an industry are built upon shifting currents, there’s no wonder that investment advisors, pensions, endowments, and other institutional investors can be confused about how to satisfy the diverse wishes of the general investing populace.

As a result, even within socially responsible-themed investment products there are many ways to express morals and values — even some virtual opposites. For fun examples, check back soon!