ESG Investing: Pros, Cons, and How to Comply (2024)

ESG investing is a type of investing that considers environmental, social, and governance (ESG) factors when making investment decisions. ESG factors include, amongst others, things like a company's carbon emissions, labor practices, and board diversity. For several years now, investors have been seeking investments that align with their morals and values - and ESG investments began with the intent to do just that. Unfortunately, the investment industry set out to create niche products that were not truly incorporating these aspects into portfolio creation. Fund managers set out to do what is common to them - provide investors with solutions that generate revenue (for the managers) and provide returns (for their investors). Because of this, regulators have stepped in not only to provide guidance and direction, but also to monitor fund managers to ensure they are complying with the requirements in labeling an investment as an ESG investment.

There are many pros to ESG investing. First, it can help investors align their investments with their values. For example, investors who are concerned about climate change may choose to invest in companies that are working to reduce their carbon footprint. Second, ESG investing can help investors manage risk. By considering not only financial performance, but also ESG factors, investors can identify potential risks that may not be apparent from financial data alone; for example, the risk of a factory being located on a site which may be increasingly susceptible to flooding. Third, ESG investing has proven to have a positive impact on the environment and society. For example, a study by the Global Impact Investing Network found that impact investments outperformed traditional investments by 3.2% per year over a 10-year period.

However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective. There is no one definition of what constitutes an ESG investment, and different investors may have different criteria. This can make it difficult for investors to compare ESG funds and ensure that they are investing in a fund that is truly aligned with their values. Lastly, there is the risk of greenwashing, which is when a company or fund makes false or misleading claims about its ESG credentials.

Here are some specific ESG factors that investors may want to monitor:

  • Environmental factors: a company's carbon emissions, water usage, and waste disposal practices
  • Social factors: a company's labor practices, human rights record, and commitment to diversity and inclusion
  • Governance factors:a company's board composition, executive compensation and incentive structure, and internal controls

Investors can monitor ESG factors by using a variety of methods and resources, including:

  • Self-reporting:Companies are often required to self-report their ESG performance to regulators. This can be done through a variety of methods, such as filing a report, completing a questionnaire, or participating in an audit.

  • Third-party verification:Regulators may also require companies to have their ESG performance verified by a third party. This can be done by an independent auditor, a ratings agency, or another organization that specializes in ESG compliance.
  • ESG data providers:There are several ESG data providers that collect and aggregate ESG data from companies. This data can be used by regulators to monitor ESG compliance and to identify companies that are not meeting the requirements.
  • ESG ratings:ESG ratings are a way to assess a company's ESG performance. These ratings are often used by investors and other stakeholders to make decisions about where to invest their money.

The specific method used to monitor and evidence ESG regulatory requirements will vary depending on the jurisdiction and the specific requirements. However, the methods described above are some of the most common approaches.

Of course, monitoring a new type of investing comes with its challenges, including:

  • Lack of standardization:There is no single, universally accepted definition of ESG. This can make it difficult to compare companies' ESG performance and to assess their compliance with regulatory requirements.
  • Data availability:ESG data can be difficult to obtain and expensive to collect. This can make it difficult for companies to comply with ESG regulatory requirements.
  • Greenwashing:There is a risk of greenwashing, which can make it difficult for investors and other stakeholders to know which companies are in fact committed to ESG.

Recommended next reads

ESG Investing: Investing for the Future Jordan Landers 4 years ago
ESG Investing Defined – A Beginner's Guide Michael Reynolds, CFP® 10 months ago
ESG Investing: A Promising Trend or Overhyped Fad? Raj Sukkersudha 1 year ago

On top of these challenges, regulators have shown that they are not afraid to impose massive fines against firms who improperly categorizing themselves as ESG:

  • Goldman Sachs: In 2022, Goldman was fined $4 million by the SEC for misleading investors about the ESG credentials of its funds.
  • BNY Mellon: In 2022, BNY Mellon was fined $1.5 million by the US Securities and Exchange Commission for misstatements and omissions related to ESG.
  • Deutsche Bank: In 2023, Deutsche is expecting to pay a fine of $30 million by the SEC for violations to mismanagement of ESG funds.

These fines are a reminder that ESG investing is a complex and evolving field. Investors should be careful to do their research and to choose ESG funds that are truly aligned with their values.

Despite these challenges, ESG is becoming increasingly important to investors, regulators, and other stakeholders. As a result, we can expect to see more innovative methods developed to monitor and evidence ESG regulatory requirements in the future.

In the meantime, firms should consider providers or solutions that will help in vetting through the requirements. As these requirements continue to evolve, the use of proper data points and accurate analytics will help in mitigating issues with regulators. Firms should also continue to have forward thinking in the monitoring of these items. As we continue to see the development and usage of AI, I envision working through these issues much more quickly and efficiently in the future.

ESG Investing: Pros, Cons, and How to Comply (2024)


What are the pros and cons of ESG investing? ›

Pros and cons of ESG investing
Can help investors diversify their portfolioESG funds may carry higher than average expense ratios
May reduce portfolio riskESG investing is still a fairly new concept and there isn't a ton of reporting on performance
1 more row
Oct 20, 2022

What are the arguments against ESG investing? ›

Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.

What are the flaws of ESG investing? ›

Lastly, there is the risk of greenwashing, which is when a company or fund makes false or misleading claims about its ESG credentials. Here are some specific ESG factors that investors may want to monitor: Environmental factors: a company's carbon emissions, water usage, and waste disposal practices.

What are the biggest challenges in ESG investing? ›

Despite the progress, ESG investing still faces several challenges:
  • Standardization and Data Gaps: There is a lack of consistent and standardized ESG data across companies and industries. ...
  • Greenwashing: Some companies may engage in "greenwashing," making false or misleading claims about their ESG credentials.
Mar 18, 2024

Do investors really care about ESG? ›

Retail investors do care a lot about the ESG-related activities of the firms they invest in, but only to the extent that they impact firm performance, independent of ESG performance.

Does ESG investing really work? ›

ESG funds have similarities to other funds

While the results from these time periods have been generally encouraging for ESG funds as a whole, we don't see convincing evidence that ESG funds are reliably better than non-ESG funds.

Why is ESG so controversial? ›

One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.

Why did ESG fail? ›

The ESG movement, originally driven by good intentions, has been co-opted by lobbyists, special interest groups and various NGOs, and recent reviews have revealed its lackluster performance in creating meaningful environmental change and have highlighted chronic abuse of flawed methodologies.

What is one limitation of the ESG investing? ›

There is a potential for “greenwashing”

Some companies may make claims about their ESG practices that are not fully supported by their actions which can lead to “greenwashing”. This may make it difficult for you as an investor to identify truly sustainable companies.

What are the negative impacts of ESG? ›

Firms with ESG controversies will likely suffer from higher financing costs and inadequate investment capability, leading to investment inefficiency.

Is ESG greenwashing? ›

Greenwashing is an exaggerated claim about something's sustainability. Consumers are wiling to pay more for "green" products, which makes greenwashing a lucrative enterprise. Environmental, social and governance, or ESG, criteria are used to help evaluate investments and reduce greenwashing.

Why is ESG difficult? ›

In an era of "alternative facts," misinformation and disinformation are two of the biggest threats to effective ESG. For example, researchers cited in ScienceDirect found that fossil fuel companies knew the impact their industry would have on the climate “at least as early as 1965."

How do investors feel about ESG? ›

Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.

What are the positive effects of ESG investing? ›

ESG also helps investors to steer clear of potential financial risks linked to poor environmental or societal practices. How can ESG benefit business? ESG can help businesses to manage potential operational, regulatory, and reputational risks to ensure long-term resilience and success.

What are the benefits of ESG for investors? ›

ESG investing can help investors mitigate risks

Focusing on ESG issues forces companies to think about the long-term sustainability of their enterprise rather than short-term profits. Most investors also think in the long term rather than the short term.

What is the negative impact of ESG on companies? ›

The researchers' findings indicate that when companies focus on nonmaterial ESG factors in their quarterly financial updates, investors interpret it as a negative sign, signaling potential issues like higher costs, inefficient resource use, and distracted management.

Is it worth it to invest in ESG funds? ›

The research showed that overall, sustainable funds have consistently shown a lower downside risk than traditional funds. And while some ESG funds are relatively new (particularly many passive ones), they've been able to show solid performance and resiliency in both good markets and bad.


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