Good Deals

Moving ESG investing forward

A sun and mountainside with an arrow delineating the side of the mountain, as if on a budget sheet.

As investors pay increasing attention to companies’ track records on environmental, social, and governance issues, trillions of dollars have flowed into the ESG investing industry.

Assets in so-called ESG funds have risen 38% globally in the past year alone, to $2.7 trillion by the end of March, according to Morningstar Direct. While Europe still dominates with 82% of the market, a burgeoning class of U.S. financial products promises investors an ROI aligned with their values.

At the same time, a backlash is growing against the sustainable investing industry, disparaged by some political and business leaders as “woke capitalism.”

In June, Associate Professor Panos Patatoukas, the faculty director of the Center for Financial Reporting and Management, brought together high-level ESG investing thinkers with wide-ranging perspectives on the direction of the industry. Berkeley Haas asked Patatoukas to synthesize some of the major discussion points.

Some argue that ESG issues cover so many variables as to be meaningless. What do you think?

I think everybody understands that environmental activities are significant, corporate governance matters, and social issues are becoming increasingly important. Where people disagree is: How do we define and verify the different types of carbon emissions? What are the corporate activities that fall under the “S” of ESG? What constitutes good or bad governance? Because there’s a disagreement of what constitutes ESG, there’s disagreement on the measurement of those dimensions.

Pooling environmental, social, and governance together into one single measure is problematic since it’s missing the granularity of the underlying data. You could think of a company with “bad” governance, with an entrenched CEO who has all the power and shareholders who lack voting power, but that same CEO might prioritize reducing the organization’s carbon footprint.

If we can agree on the definitions and measurement and we have external auditor assurance, that will completely change the field. The accounting firms can play a significant role in the transformation that’s happening and accelerate the convergence of policy, regulation, and technology that’s rewriting the ESG investing playbook.

Does removing a “brown” company from a portfolio drive change?

The goal of ESG investing is not just to make money for ESG-motivated investors but also to change companies’ behavior through engagement and divestment. One example is divesting from fossil fuel companies that have negative environmental impacts and buying “green” companies in other sectors.

But will divesting from fossil fuel companies accelerate the path to decarbonization? Where will the technology that will change our lives come from—an entirely different sector or from leading companies in this sector?

Outright divesting should be contrasted with selective divesting. Within the fossil fuel sector, there are leading companies that are innovating, investing in new technologies, and there are lagging companies that are continuing their dirty practices. An alternative would be to divest only from the laggards and reallocate this capital to the leaders. In other words, blending divestment with engagement.

What are you most optimistic about?

I think over time, we will have more transparency and more tools that will allow everyday investors to invest with their values and be more aware of what they’re investing in. And we’re going to have better data to overcome the measurement challenges, monitor corporate impact, align management incentives with long-term sustainability goals, and facilitate the allocation of capital in ideas and technologies that will drive change for good.