A Comeback for ESG Investing?

It seemed like a good idea at the time. Investors who wanted to be sure their money supported businesses that adhered to worthy environmental and ethical principles, could look for the ESG (Environmental, Social, Governance) seal of approval. Businesses, for their part, talked the talk and many (not all) tried to walk the walk. Then, there was a backlash, and it seemed ESG investing might be a thing of the past. But to paraphrase Mark Twain, the rumors of ESG’s demise have been greatly exaggerated.

The reality is that many are still quietly examining the opportunities that ESG presents. Increasingly, investors and industries realize that thinking about the future, not just the immediate payoff, may be good for the bottom line. ESG is making a cautious comeback - but this time there may be an international divide when it comes to how fully its principles are embraced.

ESG's fall from grace

To make a long story short, ESG came under fire when the validity of the standards at its foundation was questioned. The goal was to let investors put their money into socially responsible companies that prioritized some combination of environmental, social, and governance (i.e., working conditions). In practice, companies often engage in greenwashing — misleading the public to present an environmentally responsible public image — highlighting several other problems. A lack of standardization around what constitutes a responsible company, and the hypocrisy at the heart of some ratings, put off many well-intentioned investors. On the other hand, some worried that ESG investing is incompatible with maximizing shareholder value. While many of those criticisms were valid, they were not impossible to solve. Still, 2024 saw many investors abandoning their green investments.

A cautious comeback

As Bloomberg Opinion Editor Mark Gongloff wrote at the end of 2024, “Make no mistake: This is all about vibes. Fine, it’s a little bit about high interest rates, which hurt clean-energy investments. But it’s mainly vibes.” Worried about Republican backlash and the impending ascendancy of Donald Trump to the White House, investors panicked. Gongloff reported: “Despite the fund outflow, assets in climate-related funds still rose 6% from a year earlier because their prices rose, Morningstar noted.” So, it’s clear not everyone is ready to abandon the ESG ship, and those who stay the course can make money — especially if they focus on the E in ESG.

An Atlantic divide opens

At the same time, a recent market move dramatically pointed up differing attitudes towards ESG between US and European investors. A UK pension fund pulled £28 billion from US asset manager State Street over the company’s retreat from ESG investments. The funds were moved to two European funds "with a focus on responsible investment."

According to the report in the Financial Times: ' “By selecting Amundi and Invesco, we have chosen to prioritise sustainability, active stewardship and long-term value creation,” said Mark Condron, chair of trustees for The People’s Pension.'

The future of ESG investing

Investors outside the U.S. still see the value in putting their money into companies with a mission beyond building wealth. While investments in the green sector may be fueling much of the continued growth, companies that are mindful of the social and governance aspects of ESG are also seeing gains at a more modest level.

Even in the U.S., where the federal government is expected to take a hard turn away from ESG investing, states like California demand change. As Reuters reports, California has enacted several laws requiring companies with more than $1 billion in revenue to disclose their greenhouse gas emissions and their climate-related financial risks. Additionally, there is “the Voluntary Carbon Market Disclosures Act, which mandates reporting on net-zero claims and carbon offset transactions beginning in 2025.”

European sustainability standards take off

Meanwhile, in the E.U., regulations that once held European-based companies to a higher standard will soon begin to impact foreign companies - with the snappily-titled 'Corporate Sustainability Reporting Directive'. As Reuters reports, “CSRD's phased implementation, starting in 2028, will require non-EU companies with substantial EU activities to adhere to European sustainability standards. Meanwhile, CSDDD, effective in 2027, imposes due diligence obligations for human rights and environmental impacts on companies operating in the EU.”

In other words, large companies will find it harder and harder to skirt their responsibilities in the coming years.

ESG as competitive edge?

If that isn’t enough reason for companies to start taking ESG seriously and for individuals to look at investing in those organizations, they may want to look at the bottom line. The Thomson Reuters 2024 State of Corporate ESG report found several interesting points:

• 71% of C-suite and functional corporate leaders surveyed view investing in ESG as a competitive advantage
• The percentage of those leaders who say they believe ESG’s role in corporate performance will continue to grow is up 10% since 2023, now coming in at 82%
  

This shift isn’t driven by kindhearted CEOs who want to save the world. The change makes fiscal sense. As Reuters points out, “ESG initiatives also incentivize companies to operate in ways that reduce costs, increase efficiency, mitigate risk, and protect against future disruptions, especially in the supply chain.” At this point in the game, failing to plan for a future impacted by climate change and shifting consumer priorities is irresponsible, and shareholders could bear the brunt of that.

Investment firms fleeing from ESG for political reasons will likely continue to see real monetary consequences for their actions. Savvy investors will lead the way now rather than waiting to jump on the ESG bandwagon once the political tides turn again.