Sustainable investing faces the beginnings of a backlash

SINCE TIME immemorial the investment industry has sought to turn money into more money. This is not a simple trick to pull off—hence the rewards proffered to those who do it well. The complexity of picking which assets to own—rich-world equities or poor-country bonds, office blocks or orange-juice futures—contrasts with the simplicity of judging the success of those investments. The winner, put crudely, is whoever snags the most marbles while taking the fewest risks. That the money in question has helped build companies or kept governments ticking over seems almost incidental to the exercise.

This approach is starting to feel old-hat. More savers want a better idea of what their money gets up to. What if their cash could be used both to generate a pension, and improve the state of the world? “Sustainable” investment funds in the broadest sense managed $35trn of assets in 2020, reckons the Global Sustainable Investment Alliance, an industry group, up from $23trn in 2016. No issuer of shares or bonds can ignore virtuous investing. Banks increasingly refuse to lend to firms with insufficiently impressive environmental, social or governance (ESG) credentials. Consultancies assessing whether bosses are doing their bit to combat climate change or social inequality have proliferated.

Savers may bask in the feeling that their money is nudging capitalism in the right direction—while still generating returns. But the new approach is prompting the first signs of a backlash. The answers to two uncomfortable questions remain elusive. Are supposedly virtuous funds investing in appropriately virtuous companies? And is what these financial do-gooders are trying to pull off even such a good idea?

Start with whether money purportedly chasing ESG-friendly investment is reaching the right targets. Regulators have their doubts. America’s Securities and Exchange Commission (SEC) has said it wants to crack down on “greenwashing” funds that flaunt their virtuous credentials but cannot prove that they have done the needed legwork when picking investments.

On August 25th reports emerged that the SEC and its German counterpart were investigating whether DWS, a large German asset manager that has boasted of its sustainable edge, had misled customers about how much it used ESG metrics to place money. This came after its former head of sustainability questioned claims that half of the fund’s assets were invested in ways that looked beyond mere profit.

The firm denies wrongdoing. But industry practitioners admit there are so many variants of sustainable investing that savers may well be confused. Selecting firms to invest in often involves little more than a box-ticking exercise confirming that the right grade of recycled paper was used to publish the annual report. A push to improve disclosure in Europe—the place keenest on virtuous investing—led funds defined as sustainable to contract by $2trn between 2018 and 2020.

Kinks around metrics may iron themselves out as the industry matures. But that will not help with the second, deeper critique: that investors chasing virtuousness are, at best, deluding themselves and, at worst, doing more harm than good. That is the argument made by Tariq Fancy, a former sustainable-investing bigwig at BlackRock, in a blog post published on August 20th. ESG investing, he says, merely “answers inconvenient truths with convenient fantasies”.

Mr Fancy points out that for all its trumpeting of virtue, the investment industry is self-interested: keeping tabs on companies’ pledges to be better corporate citizens gives asset managers an opportunity to charge fatter fees. And for every disgruntled investor selling a company’s stock, he argues, there is another to buy it.

Even if the new approach does tweak firms’ cost of capital (by funnelling more investment to solar firms, say, and less to oil giants) this merely promotes the dangerous illusion that business can lead the way on fighting, say, climate change or racism. And if anything, Mr Fancy thinks, that pushes back the day when government action will actually take care of such problems.

What does all this mean for savers and their pots of cash? Keeping tabs on what a company is up to is no bad thing, but funds might need monitoring too. Prioritising a CEO’s statements on Black Lives Matter over the viability of her investment plans is a recipe for poor returns and a flabby corporate sector. And that would not so much nudge the capitalist model as derail it.

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This article appeared in the Finance & economics section of the print edition under the headline “Profit and dross”