ESG Misconceptions: Putting Problems in Perspective Can Lead to Better Solutions

Abstract

The deliberate application of material environmental, social, and governance (ESG) considerations in investment analysis, security selection, and portfolio construction is a comparatively new phenomenon in investing. Material ESG factors are those relevant for investment performance. As the application of ESG has become more pervasive, it has come under increasing scrutiny. However, some common critiques, such as the use of proxies for unobserved data, are equally applicable to traditional financial analysis but are unrecognized as such. And in some cases, it is not necessarily clear why, or to what degree, identified problems, such as ratings disagreement, are problematic or unique to ESG. In this article the author examines some common critiques and misconceptions of ESG and suggests why they may be more debatable than is generally acknowledged. New regulation and disclosure rules intended to address these issues may be counterproductive to the extent the rules are premature or poorly designed.