For environmental investors, there is a sliver lining to the shakeout in ESG

Gertjan Van Der Geer, Senior Investment Manager and Stephen Freedman, Head of research and sustainability, Thematic Equities, Pictet Asset Management.

ESG investing appears to have hit a major roadblock.

Donald Trump’s return to the White House has set off a fierce backlash against the use of environmental, social and governance (ESG) principles in investment.

In the US, a growing number of large financial institutions including BlackRock , Fidelity and JP Morgan are paring back their climate and social commitments.

Many American investors have also voted with their wallets. US ESG-labelled funds have suffered nine consecutive quarters of outflows; in the final three months of 2024 alone, some USD4.3 billion was pulled from such vehicles, double the amount seen the previous quarter [1].

This shift has been accompanied by a proliferation of new investment funds that exclude ESG criteria altogether. Outside the US, the picture is hardly more encouraging. Investment flows into ESG labelled funds worldwide have fallen to their lowest since 2018 [2].

Yet for all this, there are reasons to welcome the ESG shakeout. Even before the political storm, ESG was hardly an unalloyed success. There have been high-profile cases of companies and investment funds using ESG labels to make exaggerated claims about their environmental credentials. Such behaviour was so rife it gave birth to a new term: greenwashing.

ESG ratings systems are not without their shortcomings, either. Many popular scoring frameworks can be confusing and sometimes contradictory. They usually highlight risks to a company’s revenue growth or future profitability but fail to capture a company’s true impact on the environment and society [3].

A related problem is that ESG in its original form gave the false impression that investors can contribute to sustainability by simply excluding or getting rid of high polluting firms. Research shows that this approach has failed to alter the behaviour of companies whose practices need to change the most. Nor has it improved investor returns [4].

So even if ESG is suffering a serious setback, its troubles present the investment industry with an opportunity to recast sustainability. With a more thoughtful approach, the re-appraisal could well lead to the more judicious deployment of capital.

[1] Morningstar

[2] Institute of International Finance

[3] https://am.pictet.com/ch/en/intermediaries/investment-views/active-equity/2023/a-review-of-esg-ratings

[4] https://e4s.center/news/divestment-it-is-hard-to-do-well-while-doing-good-latest-e4s-report-shows/