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ESG is more than just an abbreviation; it’s a movement attracting billions of dollars from investors. 

According to Bloomberg, 2021 was a record year for ESG (which stands for environmental, social, and governance) investing. More than $120 billion was invested into sustainable funds, up more than 100 percent from the previous year.

But many still wonder: What is ESG, and can it be a force for meaningful change?

In the first virtual session of the Unpacking ESG series—hosted by Chicago Booth’s Rustandy Center for Social Sector Innovation and the George J. Stigler Center for the Study of the Economy and the State—a panel of academic and industry thought leaders discussed the current state of ESG investing. 

What ESG is trying to accomplish is complicated, said Chicago Booth’s Rob Gertner, the Joel F. Gemunder Professor of Strategy and Finance and John Edwardson Faculty Director of the Rustandy Center for Social Sector Innovation. ESG could be a corporation holding itself socially responsible, an investor wanting to express its opinion with money, or an employee wanting to express their worldview through where they work.

Here are four things to consider from this conversation on how ESG could be a force for social and environmental change. 

Who’s driving?

The money flowing into ESG makes organizations pay more attention to what stakeholders think, Gertner said. Rather than simply managing ESG-related business risks—how a new product might affect the environment, for example, or how to handle a social media firestorm—organizations want to know how their investors view the risks. 

This follows to other stakeholders. Organizations see that customers care about supply chain and environmental issues, Gertner said, and employees care about what role their business plays in the world. Considering these myriad views changes how an organization thinks and operates. 

“To what extent are investors pushing companies more because of the values held by investors?” Gertner said. “Or are companies merely responding to these other forces that are coming from consumers and from workers?”

Blake Pontius, director of sustainable investing and global portfolio specialist at William Blair, views ESG as having multiple drivers, such as evolving societal expectations and investor pressure. But no matter the driver, ESG now matters financially.  

“We view [ESG] as part of having very good fundamental research,” Pontius said. “As an asset manager in the 21st century, you have to be integrating these factors to have a better risk-adjusted return profile.”

Beyond the environment

While much of the focus on ESG centers on sustainability— the 2020 US SIF Foundation’s biennial Trends Report found that investment in sustainable funds increased 25-fold between 1995 and 2020—the social and governance factors are also important.  

But these two factors lack the same consistency of measurement as the environment. One challenge with having social metrics is that the definition of a good social organization may differ for every person, said Liz Michaels, AB ’88, MBA ’06 (XP-75), co-head of BlackRock’s Aperio.

Governance factors are similarly complex, as they depend on what principles of corporate management are favored by investors. For example, what is the racial makeup of the board? Is the CEO also the chairman of the board? Does a corporation’s board oversee the supply chain to ensure no human rights violations? 

“Those are the kinds of nuances that ESG investors are looking at to make sure that what they want to see done is happening and being done reputably,” Michaels said. 

Metrics are still a challenge

While metrics are improving on environmental issues, Gertner said the lack of consistency in measuring social and governance issues makes it difficult to compare ESG across companies. Most organizations use self-reported data while using different metric definitions and leaving out data. 

“There’s a long way to go to get to a point where the metrics are easy for an individual investor—or even a sophisticated asset manager—to get a sense of the ESG performance of any firm and compare it to others,” Gertner said. 

Moderator Chris Wheat, ’10, executive director of the Stigler Center, asked if the government could play a role in creating standard metrics. Michaels said there might be a role for standardization, but the fact that the current data is so messy gives alpha-seeking investors an opportunity to find lucrative investment targets. 

And a big problem with creating imperfect measurement standards is that they can be manipulated, Gertner said, as is the case when companies practice greenwashing

“And that can end up doing a reasonable amount of damage, reducing transparency, and even creating opportunities for companies to look good on the metrics without actually performing up to par,” Gertner said. 

More transparency needed

When panelists were asked what they want to see from ESG conversations in 2022, all three pointed to increased transparency.

Gertner, for example, wants to see more disclosure and transparency for how companies exert political influence. Michaels wants more companies to disclose their workforce data to get a better picture of average organizational makeup. And Pontius wants more transparency on the market’s investment products, which he said are still confusing, even for institutional advisory clients. 

“Better articulation of the process, characteristics, and objectives that you’re targeting, as well as better reporting on portfolios and specific metrics, would help demystify what ESG means from an investment product perspective,” Pontius said. 

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