ESG’s Internal Scorecard

Environmental, social, and governance (ESG) metrics for publicly traded companies has become one of the fastest growing movements in the investment management industry. The expectation is that companies who implement strong ESG metrics will become more profitable and valuable over time by improving the interests of society, which should provide investors in these companies with excess returns. While the movement towards focusing on ESG metrics has spawned numerous new ways of packaging financial products for investment management companies, the ability to objectively measure impact investing is still in its infancy, and so far been hard to objectively quantity. This blog post from Aswath Damodaran at the Stern School of Business at NYU analyzes some of the challenges in navigating the ESG investing environment, and what investors should be cognizant of when they embark into this space. One of the challenges with ESG investing is that the measures are inherently qualitative, and there is little consensus on what weights to assign to these metrics. Furthermore, the causality issue of whether companies perform better because they have strong ESG measures, or whether companies that are performing well find it easier to implement strong ESG measures has yet to be determined. Not only are these important questions still being debated, but there hasn’t been conclusive evidence that ESG focused funds outperform their counterparts. Specifically, there has been pushback that when accounting for sector tilts of ESG funds, the outperformance goes by the wayside. This rather skeptical look at ESG investing might not matter for investors who prefer to allocate to these companies or funds for moral reasons, but they are important questions to tackle as this segment of the market grows. However, fund flows are the one thing that is not debatable, and the data shows that this is becoming an area of focus for many market participants.