In 2004, a group of private and public financial organisations published a report entitled "Who Cares Wins", at the invitation of UN Secretary-General Kofi Annan. The aim of the report was to develop guidelines and recommendations on how environmental, social and corporate governance aspects could be better taken into account in asset management, securities trading and financial research.
The report states: "A better inclusion of environmental, social and corporate governance (ESG) factors in investment decisions will ultimately contribute to more stable and predictable markets, which is in the interest of all market actors"
No common-sense financial analyst or business leader could have objected to the proposition that a business which is badly managed, behaves antisocially and systematically harms the environment is not an attractive investment in the long term and should therefore not enjoy a lasting right to exist on the market. Seen in this light, the call to consider "ESG criteria" when investing seemed like a call to invest with common sense. However, common sense is often an all too scarce commodity. The "ESG criteria" of the Annan Report have been narrowed down to partial aspects which produced mechanical rating systems and government bureaucratic monsters.
Rating agencies have developed various "ESG ratings" that measure environmental friendliness, social compatibility and proper management according to bureaucratically prescribed criteria. In doing so, however, the agencies go far beyond what can be measured quantitatively. Ratings were originally created to measure the probability of default on loans. Although qualitative factors also play a role, a quantitative statement can be made on the basis of key figures from the profit and loss account and the balance sheet analysis.
In contrast, the concept of sustainability is very complex and involves conflicting goals. Neither can it be defined without contradiction with the sustainability goals of the United Nations, nor can it be broken down to the three factors "E", "S" and "G". It is impossible to implement the sustainability goals without contradictions or converting the ESG criteria into a measure for "rating". Subjective and selective assessments dominate. Consequently, it is not surprising that the ESG ratings produced by the agencies are often inconsistent with each other.
Investment universe narrowed
In the capital markets, fund providers have promised their clients higher returns from "sustainable" ("ESG") investments. They may have been influenced by the assessments of the Annan Report. Indeed, ESG investments have at times outperformed the overall equity market. However, this was due to politically stimulated money inflows and not to higher earnings prospects for these ventures that would justify higher returns. In the long run, common sense says that investments selected according to ESG criteria must yield a lower return than the market as a whole; because if the investment universe is narrowed to ESG-compliant stocks, the investment universe is narrowed down to ESG-compliant securities and investment funds, this concentration on a more limited selection of securities means lower returns are to be expected. In fact, the promises made by the providers have not been fulfilled either.
Especially after the Russian war of aggression on Ukraine, they must now answer uncomfortable questions: Why had many Russian companies received similar ESG ratings as comparable European companies? How was it possible that around 300 ESG Funds were involved in Russia and their investors have to reckon with losses of more than eight billion US dollars?