The good ship: thoughts on the “ESG Backlash”

The good ship Sustainability was hit by yet another wave last week when Aswath Damodaran, a professor of finance at the Stern School of Business at New York University, wrote in the FT that “ESG is beyond redemption…May it RIP”.

While his arguments were more polemic than academic (it is Halloween and I sensed the spirit of Elon Musk’s “ESG is the devil” rant), it was a sign that the “ESG Backlash” continues to rage.  As sustainable or ESG investing has become more mainstream, it is encountering a backlash from various quarters, against its methodologies, its results, its very raison d’etre.

So, is sustainability a sinking ship? Not quite. To get to any promised land one must voyage across choppy waters. Currents can be deceptive. A storm may push a ship in the right direction. It is possible to view much of the backlash as unsurprising and necessary as the world shifts – as it must do and surely will – to a more sustainable footing.

A storm has many origins, but one flutter of the butterfly’s wings can be traced back to 2020, when sustainable finance was a light amid the darkness of the pandemic. This was a test for sustainable investing, but it met the Covid-19 challenge with flying colours: investors flocked to ESG funds, believing sustainable capitalism could lead the world not only out of the pandemic, but on to conquer other global problems such as climate change, while also delivering stellar investment returns.

From these vibrations, a backlash emerged. Oil executives in Texas complained that large US banks had stopped doing business with them and from there, the wind began to howl: with the tit-for-tat barring of asset managers from winning state business because of their stance on climate change; with legislative fights between companies and politicians on societal issues; with accusations that ESG caused corporate failings, such as the collapse of Silicon Valley Bank.

To some extent, this response was predictable: sustainability was challenging the established order and not for the first time, incumbents felt threatened as business and society changed around them (for more on this look up Leonard Leo).

Added to this mix were fundamental problems with sustainable investing: the rise of greenwashing; the creation of imperfect regulation; the devil of ESG ratings; debates about the social utility of defence companies due to the war in Ukraine; and confusion about the role of fossil fuels amid an energy crisis.

Each added to the battle cries as the war on “woke capitalism” escalated.  Since the beginning of 2022, the backlash has had some handy allies, namely the underperformance of “ESG Funds” and weaker fund flows. Call it woke-destocking if you like. This, amid an inflationary and supply chain crunch that threatened the economics of high-profile renewable projects, as seen in offshore wind auctions.

Rather than weathering the storm, politicians, under the guise of leadership, have too often responded as leaves in the wind. See Rishi Sunak’s net zero U-turns; Sweden – the first nation to set a milestone target for net zero emissions – acknowledging that it will miss its 2030 and 2045 targets; the pulverisation of the German coalition due to heat pumps; and the upcoming US Presidential Election, where not a single Republican candidate felt able to publicly acknowledge humanity’s role in causing climate change.

It was Churchill who lambasted politicians who “delight in smooth-sounding platitudes, refusal to face unpleasant facts, desire for popularity and electoral success irrespective of the vital interests of the State”. For the state, read the world. Current climate polices have us on track for 4oC of warming by 2100 according to the Stockholm Resilience Centre. But what is that against a few more years in power?

Criticism and forensic analysis of sustainability claims and targets is of course necessary. A major problem is that the terms ESG, sustainable, responsible et al, are used interchangeably. Agendas emerge, fuelling unnecessary fires. Unilever, under the leadership of former CEO Paul Polman, became a sustainable beacon for some, but trying to find a social mission for Hellmann’s mayonnaise always felt a stretch. Some shareholders suggested that management had “lost the plot”.

This year, numerous articles have (somewhat gleefully) proclaimed the “bleeding out” of ESG funds but have failed to mention that the few hundred million of UK fund outflows represents less than 1% of the responsible investment market, as defined by the IA. Both examples are two sides of the same coin: differing visions of sustainability used to support the cause at hand.

ESG ratings fall foul of this. In a world where “A” is good and “C” is bad, their methods and conclusions deserve scrutiny. But choosing to own a company’s shares because it is rated “A” for ESG is as non-sensical as purchasing shares simply because a sell-side bank has a “Buy” recommendation. Of course not all ESG ratings agree. When was uniformity of opinion something desirable in financial markets? There is a difference between ESG as a product and ESG as a component in an integrated investment process.

What is the solution? Damodaran’s critique that “ESG scores today measure everything — consequently, they measure nothing” is a pithy line, but it doesn’t hold up. Measure everything. Improved data analysis means a more complete picture – something every investor strives for, be it measuring carbon footprints, weighing balance sheets, or hedge funds sending drones into the sky.

And when it comes to the important issues of the day, criticism works both ways. If you are going to spell out the “unacceptable costs on hard-pressed British families” of aiming for net zero, what then of the counter-factual? The costs of failing to address climate change have been estimated in the trillions.

By all means hail the anti-ESG stance of Republican members of Congress but acknowledge the local support: half the wind energy produced in the US comes from four red states, home to farmers (and their Republican governors) who are enjoying the fruits of President Biden’s Inflation Reduction Act.

Does this all come down to human wiring and what behavioural economists call present-bias? If short-term benefits are available, we will take them, but five-years out may as well be an ice age. Blame evolution. It is how we are built. Which is why investors must hold the long-term science in mind. It is this science which informs us that considering sustainability factors and ESG data must be a fundamental part of investing and allocating capital for the future.

It is for a better future that we should invest. Acknowledge the backlash – its lessons and its faults – and make the long-term case for considering ESG and sustainability when investing. Now is not the time to abandon ship.


The views expressed in this article are those of the author at the date of publication and not necessarily those of Montanaro Asset Management Ltd. The information contained in this document is intended for the use of professional and institutional investors only. It is for background purposes only, is not to be relied upon by any recipient, and is subject to material updating, revision and amendment and no representation or warranty, express or implied, is made, and no liability whatsoever is accepted in relation thereto. This memorandum does not constitute investment advice, offer, invitation, solicitation, or recommendation to issue, acquire, sell or arrange any transaction in any securities. References to the outlook for markets are intended simply to help investors with their thinking about markets and the multiple possible outcomes. Investors should always consult their advisers before investing. The information and opinions contained in this article are subject to change without notice.

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