Is ESG worth the hype?

Inflows into sustainable funds grew to over $50b in 2021 from only $5b in 2018.

Companies have over the years delved into improving their ESG as seen in the growth of inflows into sustainable funds between 2018 and 2021.

Citing the Global Sustainable Fund Flows: Q2 2022, McKinsey Sustainability noted that inflows rose to over $50b from only $5b in 2018. The funds further grew by $87b of net new money in the first quarter of 2022 and by $33b more in the second quarter.

Despite this, ESG is facing its fair share of criticisms. In an article, titled “Does ESG really matter–and why?,” McKinsey Sustainability cited four main objections to ESG.

1. ESG is not desirable, because it is a distraction

ESG is somehow perceived more as a public-relations stunt, or as a way to bank on the higher motives of customers, investors, or employees.

McKinsey noted it is seen more as “something good for the brand, rather than something foundational to the company strategy.

Some critics associated ESG with “greenwashing,” “purpose washing,” or “woke washing.”

2. ESG is not feasible because it is intrinsically too difficult

Another criticism of ESG is whether it is feasible as companies face the challenge of striking the balance in implementing the ESG components.

Solving for a financial return will subject companies to various considerations as it involves multiple stakeholders.

“To whom should a manager pay the incremental ESG dollar? To the customer, by way of lower prices? To the employees, through increased benefits or higher wages? To suppliers? Toward environmental issues, perhaps by means of an internal carbon tax?” the report read.

“An optimal choice is not always clear.”

3. ESG is not measurable, at least to any practicable degree

ESG is difficult to accurately measure as it is compounded by differences in weighting and methodology across ESG ratings and scores providers.

“It is to be expected, therefore, those different ratings and scores providers—which incorporate their own analyses and weightings—would provide diverging scores,” the report said.

On top of this, investors have their proprietary methodologies, drawing from a variety of inputs.

4. Even when ESG can be measured, there is no meaningful relationship with financial performance

Moreover, should companies be able to measure ESG, it was argued that positive correlations between ESG and financial performance are not causative. These correlations can instead be explained by other factors, such as industry headwinds or tailwinds.