Morningstar - Q3 2022 - 19

simply claim to be using ESG metrics-when
they believe them to be material-to inform their
investment decisions. It's all in the shrug of
the shoulders: " Sure, we consider ESG data on the
chance that it might provide some insight to
our investment decisions. Why not? "
The widespread use of ESG obscures the broader
purpose of sustainable investing, makes it
easier for opponents to attack, and makes it harder
for investors who are interested in it to put their
intentions into action.
Preserving the Intention-Action Gap
Many investors are interested in sustainable
investing, but as is often the case with sustainable
products generally, there's a gap between
intentions and action. For sustainable-investing
products, the gap is wide because of the very
nature of investing. While many are attracted to
the concept, they make actual investment
decisions only periodically, based on episodic life
events like starting a new job, having a child,
receiving an inheritance, or retiring. But the
use of ESG terminology isn't helping reduce the
intention-action gap.
In a recent survey conducted by NORC for the
Finra Investor Education Foundation, retail
investors indicated strong support conceptually for
sustainable investing. More than half of
respondents (57%) agreed that investing can be
a way to make positive change in the world,
and only 37% agreed that a company should focus
on maximizing earnings and not pursue social
or environmental goals.
Yet only one in four respondents could correctly
define ESG, and only one in five could say
what ESG stands for. Not surprisingly, only 9% said
they hold ESG investments, 4 times fewer
than those who do not even know whether they
own ESG investments.
By using the nonintuitive descriptor ESG, we are
making it harder for investors to put their
intentions into action.
Providing Fodder for Opponents
An ill-defined concept is vulnerable to attacks and
caricatures from opponents. This happens in
politics all the time. When an appealing candidate
or new idea emerges, opponents try to move
quickly to define them in negative terms before
they can fully define themselves.
That's happening today both inside and outside
the investment world. The worst examples
inside the investment world are based on the
straw-man assumption that ESG investing
simply sorts companies into " good " and " bad "
based on questionable metrics, then invests only
in the good without any further financial or
valuation considerations. Such a naive approach,
they claim, is doomed to underperform and
distracts companies from focusing on maximizing
shareholder profits.
Much more troubling is the growing animosity
toward ESG on the political right in the United
States. In their telling, ESG is just one more front in
the anti-American progressive takeover of the
country. Former Vice President Mike Pence came
out swinging in a speech in Texas in May, saying
that " capricious new ESG regulations " are
allowing " left-wing radicals to destroy American
energy producers from within. "
Fresh off their success vilifying critical race theory,
the right is trying to give the same treatment
to ESG. They took an academic concept, CRT, not
widely understood, defined it as radical, and
used it to vilify something that had been widely
supported: the idea that students need to
better understand the legacy of slavery and racism
in the United States.
Now they are taking a concept, ESG, not
widely understood either, and using it to vilify
something that is also widely supported:
the idea that companies should focus on creating
value for all stakeholders, address a diverse
employee base, and take steps to alleviate the
climate crisis.
To underscore that point, Just Capital released
poll results in May showing that more than
80% of Americans believe corporations should
alleviate the pay gap between CEOs and
median workers and pay a living wage to all
its employees. Earlier Just Capital polling found
that 75% believe corporations should " make
morningstar.com/products/magazine
19
changes to ensure all aspects of their business
are environmentally sustainable. "
Narrowing the Scope of Action for Companies
Use of the term ESG rather than sustainability
seems to be getting more popular in the
corporate world, as well. Writing in the MIT Sloan
Management Review, Andrew Winston recently
noted the increased use of ESG terminology
by companies and linked it to " the investment
community's arrival on the sustainability scene,
at long last. "
Unfortunately, Winston argues, the use of ESG
may reduce corporate perceptions of the
scope of action needed to embed sustainability
into their business. It may lead companies
to think of their sustainability challenges more
narrowly in terms of addressing a set of
specific ESG issues while discouraging broader
thinking about how to shift to a stakeholder
model and define purpose beyond maximizing
shareholder returns.
Is the Glass Really Half-Empty?
Winston does acknowledge that the glass may
be half-full rather than half-empty. Terminology
aside, it's a good thing for companies to know that
investors are now " on the scene " alongside
employees, customers, and citizens. I concur. This
grand coalition is encouraging companies to
address their sustainability challenges and embed
sustainability thinking into their businesses.
But this is a reminder that words matter, and using
the term ESG rather than sustainability may
be obscuring more than it is clarifying. And that,
in turn, may lead to less substantial outcomes
than the world needs right now. K
Jon Hale, Ph.D., CFA, is a director on Morningstar's
sustainability research team. He is a member of the
editorial board of Morningstar magazine.
https://www.morningstar.com/authors/1855/jon-hale http://www.morningstar.com/products/magazine
Morningstar - Q3 2022

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