The complex problems of our world cannot be solved by numbers. And quantitative analysis will never be able to drive the positive social changes we need, Stuart Dunbar writes in an essay finews.first.
This article is published on finews.first, a forum for authors specialized in economic and financial topics.
The desire to invest more sustainably has had unintended consequences: Mapping ESG values has degenerated into a dull exercise of measuring, ticking boxes and converting into scores. This has little to do with what sustainable investing should achieve.
The complex problems of our world cannot be solved by numbers. Quantitative analysis will never be able to drive the positive social changes we need. It will not help us increase the productivity of our economy, nor improve our living standards or ensure that our world remains livable. For this, we need to take a holistic approach, especially when it comes to sustainability, i.e. ESG issues.
«The weakness of quantitative ESG approaches can be clearly illustrated»
For many investors, sustainable investing means nothing more than buying a fund that passively mimics an ESG index. This approach is particularly widespread for climate-friendly investments. In principle, there is nothing wrong with investors wanting to achieve a more sustainable portfolio or one with a smaller carbon footprint. Dogged criticism is therefore not appropriate. And yet this approach is a misguided one: because if we base our investment decisions only on snapshots of metrics, we are a long way from sustainable asset formation that is aligned with a holistic ESG concept.
This is because the ESG metrics used to focus more on the systemic risks of a portfolio than on the opportunities made possible by the positive behavior of individual companies. The weakness of quantitative ESG approaches can be clearly illustrated by the contrasting ESG scores of different data providers on the same company (see chart).
(Click on the graphic)
But why are the scores so different? Because they are highly subjective. Asset managers and investors alike need to be aware of this. The ESG ratings they rely on may not match their own interpretation of responsible investing at the relevant time or in a particular area.
In our opinion, sustainable investing, therefore, requires a holistic and very specific approach: In particular, investors should engage with individual companies themselves and in a targeted way to find out whether and to what extent the companies are facing up to the challenges of the real world. This includes actively maintaining dialogue and encouraging companies to change and drive progress.
«This is precisely where the limited quantitative snapshot of corporate ESG assessment fails»
Our global society is structured in such a way that it needs many things produced by industries that are deemed to be harmful to the environment. International supply chains rely on airlines. Knowledge needs to be shared, and despite digitization, much of it is still only available in paper form. Food must be packaged. Roads, bridges and buildings need to be built – especially in developing countries.
The bottom line, in our view, is to focus on reducing the impact of these activities rather than pretending we can do without them. This is precisely where the limited quantitative snapshot of corporate ESG assessment fails. A thoughtful approach to sustainable growth, on the other hand, not only addresses the ESG challenges of our time, but it also opens investment opportunities.
«A meaningful approach to sustainable investing may be messy and difficult to quantify»
We are convinced that companies that meet society's needs and challenges will also be financially successful in the long run. After all, the capitalist motive of companies is not the enemy, it is the mechanism that spurs and harnesses human creativity and development. Of course, we must not forget that for sustainable progress we have to think in the long term. We must also assume that companies doing business in an irresponsible and harmful way will be held to account by their consumers, governments, regulators and investors – and made to change.
A meaningful approach to sustainable investing may be messy and difficult to quantify. But if investors integrate ESG factors and principles holistically into their analysis, focus on sustainability as an opportunity, and clearly explain the rationale behind their investment decisions, they can meet the real demands placed on them by the three ESG dimensions of sustainability.
Stuart Dunbar joined Baillie Gifford in 2003 and is a Director in the Clients Department. He became a Partner in the firm in 2014 and is responsible for overseeing relationships with financial institutions, as well as contributing to consultant relationships, marketing and client servicing activities in Europe and Asia. Prior to joining Baillie Gifford, Stuart worked with Dresdner RCM in Hong Kong and Aberdeen Asset Management in the U.K. He graduated BA in Finance and Business Law from the University of Strathclyde in 1993.
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