How to keep ESG moving ahead in the face of political madness

By Sancia Dalley and Kerry Kennedy

Imagine a money manager trying to sell you on their ability to invest your retirement savings. After a long pitch, you say, “ When you invest in a company, do you see first if it has a history of environmental damage? Do you check to see if the company uses child labor? A history of corruption?” The money manager responds, “We don’t believe that ESG considerations play a role in risk management. So no. We do not.”

Would you still invest?

In Florida, Texas, and, more recently, Louisiana, sweeping legislative changes are prohibiting public retirement plans from investing in funds which take environmental, social, and governance (ESG) factors into consideration as either risk factors or as a segment in which to invest.

While asset managers such as Blackrock share Robert F. Kennedy Human Rights’ belief–that ESG is a valuable tool to guide investments toward profitable, impactful outcomes–there are fund managers and institutional investors who attack ESG considerations on purely political grounds. This includes those who use its popularity to secure capital without establishing rigorous metrics.

Rigorous metrics are the panacea

Before 1931, there was no way to compare the valuation of one company to another. But in 1932, the Universal System of Accounting was established, and finally, investors could compare company valuations with confidence.

Before 1952, there was no way to compare risk from one company to the next. But that year, economist Harry Markowitz wrote his dissertation on modern portfolio theory, which transformed the landscape of risk assessment.

Today, we are on the cusp of a third investment management revolution—one which considers the risk of environmental, social and governance factors when evaluating risk adjusted returns. The success of this revolution will depend on the standardization of factors and the rigor of compliance.

Bring more transparency to ESG reporting

Collecting and analyzing data is at the core of the investment sector, and the reporting on ESG lags tremendously. A hodgepodge of guidelines from ratings firms and elsewhere purport to measure a company’s ESG footprint. But no one, we must stress, is holding anyone’s feet to the fire to ensure consistent metrics for what we are asking companies to report, let alone accurately assessing impact. And the ratings firms have largely done a dismal job of segmenting and reporting ESG social and governance targets especially.

The “S” data, in particular, is hard to find, and it’s essential to understanding important inputs such as labor practices, which can harm a company’s reputation—and share price—when not conducted properly. But what’s measured tends to be what’s most convenient, not the most meaningful, as the NYU Stern School of Business noted in their report, Putting the S in ESG—Measuring Human Rights Performance for Investors. Take note: The Wendy’s hamburger chain, at a recent shareholder’s meeting we attended, claimed it was ESG compliant because in addition to efforts on “E” and “G” issues, it addresses the “S” by giving annual donations to orphanages in honor of their founder.

ESG only reaches its full potential when we have a standardized disclosure framework that allows us to compare performance using reliable, measurable data that is audited periodically for accuracy.

Ultimately, we may need legislation to promote transparency in reporting. The US would be in good company here, as 72% of countries examined by the UN Principles for Responsible Investing required mandatory disclosure on sustainability (and 44% had regulations, or proposed regulations, requiring pension funds to consider ESG in their fiduciary responsibilities).

Focus on the pre-due diligence process to generate long-term impact

For many investors, particularly the large institutional kind, due diligence is frequently outsourced to consultants who only scratch the surface with their ESG-related inquiries.

Before this outsourcing occurs, we have developed a practice of encouraging investors to be clear on the difference between investments that proactively attempt to solve a social or environmental problem (impact investing) and investments that analyze risk (ESG investments) as part of their fiduciary duty. Making this distinction is a critical step for the investor in order to get at the tough but impactful nuances while offering clearer guidance to their consultants.

Profit at all costs is an unacceptable approach to fiduciary responsibility in today’s social and economic climate. Consider the company that shifts labor to cheap, predominantly unregulated markets lacking basic worker protections let alone requiring a livable wage. An ESG-minded approach would weigh the extraction of the maximum resources and profits possible with the long-term human rights and reputational risks.

Investors can set this kind of diligence tone with their consultants, who by extension are expected to do so with portfolio companies in both the private and public markets. There is never a good excuse for the failure of due diligence by the responsible fiduciary, and this is especially pertinent when looking at ESG risks.

Pay attention to all three letters of ESG—and how they intersect

It’s imperative for investors and companies alike to approach their ESG framework with the type of thoughtful integration that’s needed in order to maximize both returns and impact.

While investing in alternative solutions like biodegradable raw materials or building wind farms is good for the environment, and among the easiest forms of ESG to report and measure, proper consideration also must be given to social and governance issues. Condoning the hiring of child workers in your supply chain, preventing workers from unionizing, or doing business with dictatorial regimes that regularly violate human rights are all counterintuitive to the whole ESG approach to doing business.

We understand that managing all of these issues takes work—and acknowledge that we are all operating in a flawed market. But while wins are important and reputationally boosting in the short term, focusing on the tougher opportunities long term is where impact and profit can and should have outsized returns for investors, companies, communities, and the planet.

Kerry Kennedy is a human rights lawyer and the president of Robert F. Kennedy Human Rights. Sancia Dalley is senior vice president of strategic partnerships and investor engagement, directing RFK Human Rights’ Compass Investors Program.

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