Criticisms around ESG fall into five categories, only some of which are based on fact, with many of the problematic aspects of ESG likely addressable through better and more throrough reporting and communication, according to research from PitchBook Data.

The areas of concern focus on ESG being subjective, that it requires sacrificing returns, that it is redundant, that it distracts from the most important issues, and that it is virtue signalling.

Anikka Villegas, analyst, fund strategies and sustainable investing at PitchBook, said: “While some of these sentiments are well-founded concerns, others are partially based on misinformation, and many are taken to a degree of absolutism that strips away their validity. By dissecting which aspects of the sentiments are grounded in fact and which are not, important nuance is added back into conversations about ESG.”

Concerns around ESG being subjective are sometimes well-founded. As one North America based limited partner (LP) told PitchBook: “ESG is increasingly difficult to measure and frequently involves greenwashing. We appreciate companies pursuing environmental objectives but find the S and G components are too subjective and not accurately reported.”

However, the PitchBook research noted: “There is good and bad to this subjectivity: the good lies in the ability of any private market participant to theoretically find an approach to ESG that is palatable and customisable to them, and the bad lies in misaligned expectations and difficulty distinguishing between the ESG approaches of fund or asset managers and benchmarking them against one another.”

For example, one manager’s ESG strategy might necessitate investing in only carbon-neutral businesses, while another’s might involve acquiring companies in “dirty” industries such as oil, coal, and gas and making ESG improvements to them where possible.

If both asset managers have funds they describe as ESG-aligned, an LP might expect the use of one strategy and find that it has invested in a fund that uses the other. This kind of dissonance between what one party expects from another’s ESG strategy has resulted in greenwashing accusations, feeding into negative perceptions of ESG.

Villegas said: “It is therefore necessary for GPs [general partners], LPs, and portfolio companies to all proactively communicate about what their approach to ESG entails, what its purpose and goals are, and how it will be implemented.”

The research identified another oft-cited concern that “ESG requires sacrificing returns and constitutes a breach of fiduciary duty”.

Anikka Villegas at Pitchbook

“As ESG has proliferated and discussion of it has intensified, it has become more difficult to distinguish between well-founded concerns and critiques based partially on misinformation”

Anikka Villegas, analyst, fund strategies and sustainable investing at PitchBook

PitchData’s research said this view was partically based on misinformation “as ESG does not require investors to sacrifice returns for the sake of creating positive social or environmental outcomes, a practice sometimes referred to as accepting concessionary returns”.

And many consider ESG to facilitate the opposite by limiting downside risk.

What is clear, however, according to the study, is that making ESG-related improvements that will not benefit a company or portfolio nor prevent harm to it would likely constitute a violation of fiduciary duty.

As such, overinvestment in sustainable industries, complete avoidance of high-ESG-risk industries, and unnecessary spending on ESG programmes at the company level increase the risk of a fiduciary duty breach.

Yet rejection of ESG entirely is not a solution, as failing to assess and address material ESG risks can also result in a breach of fiduciary duty. Thus, market participants must walk this line carefully and be prepared to justify their ESG-related decision-making.

Villegas said in conclusion: “As ESG has proliferated and discussion of it has intensified, it has become more difficult to distinguish between well-founded concerns and critiques based partially on misinformation. There are valid concerns about ESG’s subjectivity, the difficulty of substantiating its performance, and its distraction from issues that could be considered the highest priority.

“Among those partially grounded in misinformation are the sentiments that ESG requires sacrificing returns and is inherently a breach of fiduciary duty, is redundant, and is baseless virtue signalling. By pulling apart the facts and fiction of the discourse around ESG, we help redirect the conversation to the issues that must be addressed for ESG to bring the most value to the markets and to stakeholders.”

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