ESG Investing: Conceptual Issues

Abstract

Using criteria based on environmental, social, and governance (ESG) considerations has become an increasingly important aspect of investment decision making, particularly for high-profile institutional investors. As of 2019, sustainable assets under management were estimated to be $30 trillion worldwide. The claim here is that the enthusiasm for ESG investing has been exaggerated for three reasons. First, it is not clear what constitutes an ESG investment in the context of a complex, integrated economy. Second, the impact on investment performance of a preference for ESG investments has not been sufficiently recognized outside academic circles. Finally, many leading practitioners have stated that the importance of ESG considerations implies that the corporate objective of maximizing shareholder value, which lies at the core of much of finance theory, is outdated and needs to be replaced by a more comprehensive stakeholder model. The conclusion is that both the benefits of the traditional model and the dangers of a broader stakeholder model have not be adequately appreciated. TOPICS: ESG investing, portfolio construction, wealth management Key Findings • Investors need to recognize that a lower cost of capital for firms with high ESG scores means lower expected returns for investors. • Returns realized as the market comes to recognize highly rated ESG companies are not indicative of long-run expected returns. • ESG policies, such as a carbon tax, need to be set by elected officials, not corporate executives who have neither the proper training nor the proper incentives.