Opinion – Rodrigo Tavares: The Economist was wrong, even if it was right

For the hesitant, the critical, the disappointed or the uninitiated, last week’s The Economist special report was a death certificate for ESG practices. Both the cover title (“ESG: Three Letters That Won’t Save the Planet”) and the harsh tone of the report (“ESG is profoundly flawed”) caused market distress. For those who apply these practices: are we wrong? For those who were thinking of applying: if The Economist is critical, then we should temper our enthusiasm.

During the week the messages dripped like a poorly closed faucet. Agree or disagree? What happened? I read the 11 pages without a unionist spirit, to, right from the start, agree with very valid criticisms of the ESG market.

There is a lack of uniformity in practices, measurements and concepts, which makes it impossible for us to know the volume of assets under management that incorporate ESG practices, allows each manager to create their own rules as if it were the “Wild West” with Paul Newman, and facilitates that ESG becomes a marketing tool.

It also highlights that the causal relationship between sustainability and financial performance is not inevitable and that ESG rating agencies lack reliability, comparability and transparency. Adding to the criticisms of the International Organization of Securities Commissions (Iosco), it unleashes its astonishment with agencies that combine consulting services with the provision of ESG data, in a clear conflict of interest.

All of these criticisms have been voiced countless times, by countless people, including repeatedly by this column.

But the report presents, in my view, four inaccuracies.

First, there is factionalism in collecting data and exposing criticism. There is a sentencing and evangelizing tone. The report does not listen, in a balanced way, to both the censors and the patrons of the cause to allow the reader to form judgments. A single precept is presented and only the testimonies and academic articles that can substantiate it are collected, without contradictory.

For example, it doubts the financial performance of ESG funds and cites two academic articles, but neglects hundreds of other econometric studies that manage to prove positive correlations between sustainability and profitability. This is a sensitive topic that requires thoughtfulness and rationality, not messianism for or against.

It argues that fund managers ESG repackage their funds in order to charge more plump management fees. The example given is ESG ETFs, with management fees about 50% higher than non-ESG ETFs. But this practice is not widespread across asset classes. The vast majority of managers that integrate ESG in equities, fixed income or in private markets do not charge more for this. If they did, they would be viewed with skepticism by the market. And if there are many managers who make up ESG practices to deceive clients, many others do a serious job.

It also cites an academic study to illustrate that the practice of divestments – when an investor sells their stakes in companies with negative externalities (e.g. tobacco, weapons or oil) – is financially irrelevant and does not increase the cost of capital of the divested companies. But several other studies demonstrate the opposite. Ironically, one from The Economist itself, from June 2015, which proved that during apartheid in the 1980s, the cost of capital of divested South African companies went up.

In addition, the report points the finger at the cavities in the ESG market, but omits all the initiatives that the market is developing to fill them. It reacts with fury to the lack of adequate regulation, but it does not give a voice to all the initiatives that are being developed in the US, UK, European Union, China or the United Arab Emirates.

It’s like killing a child for not being an adult. It is not intellectually respectable to criticize the ESG industry as a whole when its practices are still in formation or consolidation. We can criticize the slowness with which the market is creating a support infrastructure to serve as a scaffold for the ESG market, we can criticize how the still elastic texture of ESG is facilitating corporate savvy, but it’s still too early to shoot ESG as a viable tool for generation of financial, social and environmental value.

The reporter and the various editors of the story should also have taken more time to breathe. The Economist is the most influential magazine in the corporate market and the condemnatory tone of the headlines has the potential to suggest behavior. But within the long text are small contradictions with the inflammatory profile of the titles and fine lines. After all, ESG, says the author, can even be positive. “If investors invest with long-term horizons, it makes sense to adopt risk management mechanisms to track companies for issues such as climate change, regulatory or reputational damage.” In the end, it says “sustainable investments will not disappear”. The problem is that most of those who started to quote the article in The Economist did not read the text in its entirety.

The final solution presented – ESG practices should focus only on environmental issues (the E) and emissions accounting – is also reductionist. ESG has become overly complex, but the solution is not to make it overly simplistic. Climate change is not exclusively an environmental issue because it has the potential to affect dozens of social factors, such as social inequality. And should we sacrifice dozens of years of accumulated knowledge about the impacts of corporate governance on a company’s financial performance simply because the magazine thinks that “the art of running a company, or G, is too subtle to be captured by mere compliance of requirements”.

Contrary to the history of The Economist, this special report is signed: Henry Tricks. The in-house journalist is also a professional speaker and, on the website of the agency that represents him, he is presented as follows:

“Henry has become a much sought-after speaker for companies investing in ESG. Environmental, Social and Corporate Governance issues are imperative for future-proof business success as the importance of accountability to corporations is paramount. his experience, having written on this topic at the rate at which he has progressed, Henry is in demand for his proven knowledge in the field.”

Journalist Henry and Speaker Henry are not compatible. Which will survive?