Impact investing is inherently forward-looking, offering a viable alternative to ESG investing
Criticism of pursuing ESG (environmental, social and governance) goals can be broadly condensed into two points.
The first disapproval refers to the companies’ broader intent to generate profits without the distraction of ESG goals.
Businesses are typically built to generate profits with little to no thought given to how low wages, overrun production lines, and subpar product quality often create negative social and environmental effects. On the flipside, recalibrating a company’s supply chain will yield higher costs, which prompts a debate on how much intent and effort must be reserved for ESG goals.
The second challenge is the difficulty of calibrating the true impact of pursuing ESG goals. It is relatively easier to assess a firm’s performance through financial metrics, such as ROI, EBITDA, EPS, etc. Due to their qualitative nature, measuring the impact of ESG is difficult.
The problems surrounding these two ESG challenges undermine a company’s resolve to pursue green goals. Shareholders can be convinced of fulfilling long-haul ESG goals, but they seek positive and preferably high returns in the short term.
For all the odds, the ESG industry continues to grow. Nearly 9 out of 10 investors, who participated in a Bloomberg study, suggested that ESG leads to better returns, resilient portfolios and enhanced fundamental analysis. Ongoing pressure on companies to consider ESG initiatives is certainly leaving an impact on investors and corporations framing their commercial decisions.
Yet there remains the risk of greenwashing, with companies feigning environmental consciousness to bolster credibility. Deutsche Bank’s asset manager DWS was fined €25 million earlier this year for “aggressive” advertising that “did not reflect reality”.
This is not an isolated event, with several multi-national companies such as Nestle, Shell, Starbucks and Apple accused of similar transgressions. Often companies misrepresent their eco-friendly goals to generate demand.
Indeed, most companies that embed ESG in their strategic decision-making were established on the pillars of profit maximization. This means that healthy bottom lines will be the touchstone of all commercial decisions.
For vocal thinkers such as Milton Friedman, the social responsibility of businesses is to increase profits, leaving ESG considerations to regulation. So long as companies are following the law of the land, claims Friedman, there is no need for them to consider this extraneous factor.
Of course, the downside is that companies will look to circumvent laws to achieve what they wish to, not what they should. Intent, therefore, is key, which calls for an overhaul in a company’s approach. Environmental considerations must be embedded into a firm’s mission statement, diluting the notion of prioritizing financial returns as a core objective of ESG investing.
Viable alternative
Impact Investment represents a viable alternative to ESG, with the former aiming to achieve positive social good whilst generating financial returns. Rather than isolated activities such as planting a score of trees on abandoned land, impact investment conflates social good with the need to generate returns.
A good example would be investing in companies that manufacture smartphones but those that do not extract metals from conflict zones. Impact investment is inherently forward-looking.
Impact Investment also maintains a strong focus on measurability, with enterprises measured on financial returns and the impact created. Unlike ESG where goals are subjugated to financial returns, impact investment looks to an initiative’s end goal.
It may be less attractive to investors as an asset class, but its focus on long-term outcomes does combat the short-termism of conventional capitalism, and falls in lockstep with holistic principles of Islamic finance.
Rizwan Rahman is a UK trained lawyer based in Doha
