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MEASURING PROGRESS

The ESG investing conundrum: Finding meaning behind the metrics                     

A museum assistant poses in the "Cloud Room" inspired by the painting "Threatening Weather" by Belgian surrealist artist Rene Magritte during the exhibition "Dali & Magritte" at the Royal Museums of Fine Arts of Belgium in Brussels, October 11, 2019.
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But what does it all mean?
  • Judy Samuelson
By Judy Samuelson

Executive director, Aspen Institute Business & Society Program

Published

Clients drawn to socially responsible investing are told they can have it both ways—competitive or even superior returns, plus positive societal and environmental outcomes.

Yet anyone working at the interface of business and society knows this is not a win-win world; there are real tradeoffs involved.

Funds created to respond to the growing demand for investment vehicles that fit the attributes of “ESG”—environmental, social and governance—are now in a squeeze play between investors seeking assurance that their money is aligned with their morals and demands on business that become more complex by the day.

Can ESG metrics catch up?

The UK is sufficiently concerned about what’s marketed under ESG investment labels to have released in July 2021 a set of disclosure requirements and principles designed to clean up this rapidly growing, and evolving, domain of investment. The UK release follows years of debate in the EU about the need for specific measures and standards. The US isn’t far behind; in April the SEC published a risk alert, calling out fund managers seeking “gold in the green.”

These announcements will produce even more jobs to respond to surveys and data requests and to build out ESG reports and websites.

However, it’s not clear who actually reads all these reports—and the connection between either voluntary or mandatory disclosures on the one hand, and the production of useful, digestible, actionable data on the other hand, is not clear. This is equally true for investors and customers. How does a stock picker or a conscious consumer know what they are buying, given the complex and growing set of expectations on everything from reduction in pollution to racial and economic equity?

The quest for ESG disclosure

Metrics designed to make simplistic comparisons between companies may not be up to the task. Today’s emphasis on sustainability reporting has more in common with the “quality” movement that took hold of industry in the 1980s than it does with accounting or public reporting, then or since.

TQM, or Total Quality Management (lean manufacturing in today’s vernacular) recognizes that to produce a quality product requires a continuous and ever-changing process, which is not easily captured as an “outcome” or metric. It’s the same with the pursuit of trust, or sustainability, or equity: You are never done.

For one, the definition of a quality product changes as knowledge, technology, and public expectations evolve. TQM requires continuous improvement; it demands forward-looking targets and measures designed to better understand what is happening on the factory floor—not backward-looking, static metrics designed to reward or punish.

Sustainability, like quality, is not a destination. It’s a mindset—a commitment to continuous improvement. Today’s measures of progress fail to capture and guide the work that is ahead of us, whether the goal is reducing carbon across the economy, or economic mobility for workers, or building a culture of equity and fairness.

For example, a common metric used to signal a favorable culture is the diversity of the board of directors. Easy to measure? Kind of. The best window into the state of conversation and change in the company or board? Hardly.

When Goldman Sachs announced that it would no longer take companies public unless they had at least one woman on the board, it earned a lot of press, but also eyerolls. One woman of nine, or of fifteen? (If the standard was designed as a nudge, why not make it meaningful?)

The current, pitiful board stats on gender diversity make it seem like Goldman is taking an important stand and wielding its influence with less enlightened companies. Some might even fall in line. But then the ESG marketing games begin. An asset manager may create a fund made up of companies with at least one female Director—calling it the “Equity Fund” or the “End of #MeToo Fund” or the “Time to Get Serious Fund” and adding it to a platform of ESG funds marketed to investors. A small investor out there who is just trying to make sense out of an increasingly complicated world—or a large institution working on his or her behalf—will buy it, hold it, and feel good about it.

New approaches to investment and asset management are needed if the profession is going to move the needle and realize improved long-term business performance on the critical issues of our day.

A better system for measuring ESG

There are several ways investors need to elevate their game and find the meaning behind the metrics:

  1. Avoid magical thinking

Both consumers and investors tend to want it all: low price, convenience, and simple markers of sustainability and equity that help them think they are putting their money where their mouths are. Yet someone has to pay for what economists like to call “externalities”—and in recent years it’s typically not the holder of the stock who bears the brunt.

Serious asset managers need to help serious investors avoid magical thinking—for example, the belief that retailers can commit to higher wages without hurting the bottom line or the stock price, at least in the short run. Or that our use of carbon will go down without charging higher prices or displacing workers. Sustainable investment is long-term investment. The investment in workers is critically important and may pay off, but it will not be evident in the stock price—perhaps for a very long time.

  1. Pursue metrics that support management in leading the change

Jerry Muller, author of The Tyranny of Metrics, calls for measures that help managers diagnose and analyze, not just reward, or punish. An interesting example of this kind of metric was published this year by Morgan Stanley Investment Management. (Disclosure: One of the contributors is engaged in the work of The Aspen Institute.) The “culture quant framework,” as it’s been dubbed, works for serious investors as well as executives inside the company. It culls public and private data on things like retention and employee attitudes in order to better understand the underlying culture of the enterprise.

The asset managers gain insight and can both follow progress and inquire about blind spots or weaknesses in the strategy. The executive can use the data to mark progress, make course corrections, and communicate about the change they are envisioning.

Easy to measure? Not as easy as counting the number of women directors, but much more meaningful.

  1. Get beyond the smoke and mirrors

Goldman’s gender diversity metric for taking a company public points out just how far we have to go to make meaningful change. Quotas can be very useful in this regard, as difficult as they are for many to swallow, but any simple measure can become a cartoon. The investor needs context, and a time frame, and attention to the weights behind the numbers to understand the full picture.

Take, for example, the idea that we need to add “ESG metrics” to CEO pay. As long as the dominant signal in pay packages is the stock price, one or more ESG metrics may be a useful signal but is not going to change the conversation in board rooms or C-suites primed for shareholder-first thinking.

Investors can support companies on sustainability issues, but the real agency is with executives

Left to their own devices, can companies and their leaders design internal processes and measures that provide a picture window into the environmental and social performance of firms?

Fund managers who serve clients with deep pockets, and manage bespoke portfolios focused on a small subset of the market, are in a position to work directly with management on goals and improvements. Large asset managers like Vanguard and Blackrock, which both serve individuals and craft investment products for institutional investors and pension funds, scrub portfolios of problematic sectors like guns or coal, and are building out their stewardship teams to respond to demands of clients. (Disclosure: Blackrock is a supporter of the Aspen Business & Society Program.)

But asset management is also highly competitive turf. Competition for assets under management is most responsive to an even more critical financial metric: performance against the market. Will investors be patient enough to see ESG goals through?

An assist in many companies is now coming from a new voice in the ESG landscape—one that can no longer be ignored and may be the serious investor’s best ally: employees.

Employees with a real passion for the work of managing a sustainable and equitable enterprise are usually armed with direct knowledge and business insight and have social networks that link the inside of the company and the outside. These are the people who ultimately ensure an alignment between intentions and execution. Executives and investors both would do well to lean on them.

This is a time for both the investment community and boards to get serious about the ecosystem that supports business in the quest for ephemeral goals like “sustainability” or “equity.” The demand for new investment products is an important development. Both disclosure and insight are needed—along with the kind of metrics that illuminate the path forward for business and society.

Judy Samuelson is executive director and founder of the Aspen Institute’s Business and Society Program, and author of “The Six New Rules of Business: Creating Real Value in a Changing World.”

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