Time To Take The ‘E’ Out Of ESG Investing

The days when selling ESG funds was an easy marketing ploy for fund managers are over.

Investing based on environmental, social and governance criteria has been a hugely popular new market for full-service asset managers struggling to compete with low-fee tracker funds. While this type of ethical investing can genuinely mean different things to different people, scrutiny of the environmental part of the claims is rising.

On Wednesday, Asoka Woehrmann, chief executive of DWS, Deutsche Bank’s minority-listed asset-management subsidiary, said he would resign after its coming annual general meeting. The news came the day after German authorities raided the offices of both companies amid allegations that DWS made misleading claims about ESG funds. The U.S. Securities and Exchange Commission and federal prosecutors also have ongoing probes.

ESG investing has been a boon for the industry. Fund managers have often promised investors higher returns while doing good with their money. However, ESG is a slippery concept, without widely accepted definitions, criteria and metrics. Infamously, a single company’s ESG rating can vary widely between credible credit-rating firms.

That variance isn’t unreasonable. There are many ways to combine the three criteria into one score, and for any single one there can be honest disagreement about what good or bad actually looks like. For example, some might rank Shell highly on “E” because it has a plan to decarbonize its business, or poorly because it sells oil and plans to sell natural gas for years.

However, the scope for variance in environmental ratings is starting to narrow. European officials have set new rules for different categories of sustainable investments and are working on definitions of what is and isn’t green. The SEC is also working on its own set of rules. While the standards increase the compliance burden on fund managers, they should also help ensure investors are getting what they were promised, rather than just a lot of hot air.

Concerns about greenwashing—in which reality falls short of green claims—are widespread and recent events are only fanning the flames. The SEC recently fined Bank of New York Mellon $1.5 million for misleading claims about ESG funds. DWS reported far lower “ESG assets” in its most recent annual report than “ESG integrated” assets in the prior year. A whistleblower alleged last year that its disclosure was misleading. It will now be up to a new boss to draw a thicker line under the affair.

A speech last month entitled “Why investors need not worry about climate risk” from the head of responsible investment at HSBC’s Asset Management arm, in which he argued that the financial effects of climate change would be “de minimis,” only reinforced concerns that inside thinking often doesn’t match the marketing. The bank’s executives were quick to distance themselves from the now-suspended employee’s comments.

The continuing fallout at DWS is a warning to other asset managers to stand up or scale back green claims. More broadly, the tighter rules around what qualifies as environmentally friendly, even as social and governance criteria remain less well-defined, could mean it is time to take the “E” out of ESG investing—if not retire the grouping altogether. It never helped investors, and now it isn’t much use for fund managers either.

The International Monetary Fund (IMF) has described the global economy as “surprisingly resilient” amid rapid interest rate rises to quell high inflation since 2022, post-pandemic supply chain disruptions, a short-term spike in energy prices due to the war in Ukraine and increased geopolitical tensions involving China and the Middle East.

The IMF’s biannual World Economic Outlook report says the world has so far avoided stagflation and recession, with large pandemic savings enabling households to cope with higher rates and inflation, and strong immigration in advanced economies creating unusually tight labour markets.

IMF economic counsellor Pierre-Olivier Gourinchas said most indicators point to a soft landing for the global economy and the IMG now expects “less economic scarring from the pandemic”. He noted that markets had reacted exuberantly in recent weeks to the prospect of central banks lowering interest rates soon.

However, the IMF says global growth will moderate over the next five years to its lowest level in decades. It projects 3.2 percent global growth in 2024 and 2025, the same pace as 2023, with still-high borrowing costs, the withdrawal of fiscal support and weak productivity growth weighing economic activity down.

Australia is expected to underperform other advanced economies, especially the United States, this year but will surge beyond them from 2025. The IMF predicts annual gross domestic product (GDP) growth of 1.5 percent in Australia in 2024, which is well below our long-term pre-pandemic average of 2.5 percent. The US is expected to book above-average growth of 2.7 percent in 2024 and the world’s advanced economies are tipped to average 1.7 percent growth.

Australian economic growth will then move above other advanced economies and maintain upward momentum through til 2029. The IMF predicts 2 percent GDP growth for Australia in 2025 and 2.3 percent in 2029. For the US, the IMF expects 1.9 percent growth in 2025 and 2.1 percent in 2029. For the advanced economies in aggregate, the IMF forecasts 1.8 percent growth in 2025 and 1.7 percent in 2029.

The IMF said higher interest rates had had less effect on the US economy compared to Australia because most US mortgages are on long-term fixed rates and household debt has been lower since the global financial crisis. In Australia, most loans are on variable rates and therefore immediately impacted by every rate rise, household debt is high, and housing supply is restricted.

“The exceptional recent performance of the United States is certainly impressive and a major driver of global growth, but it reflects strong demand factors as well, including a fiscal stance that is out of line with long-term fiscal sustainability,” said Mr Gourinchas.

An example of unusual fiscal policy is the Inflation Reduction Act, which includes US$369 billion in new spending to encourage green energy investment. “This raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy since it risks pushing up global funding costs,” he said.

While things are going well now, Mr Gourinchas said risks to global economic progress remain.

“On the downside, new price spikes stemming from geopolitical tensions, including those from the war in Ukraine and the conflict in Gaza and Israel, could, along with persistent core inflation where labour markets are still tight, raise interest rate expectations and reduce asset prices. A divergence in disinflation speeds among major economies could also cause currency movements that put financial sectors under pressure.”

Mr Gourinchas said growth in China could falter, hurting trading partners, without a comprehensive response to its property sector downturn. “Domestic demand will remain lacklustre for some time unless strong measures and reforms address the root cause. Public debt dynamics are also of concern, especially if the property crisis morphs into a local public finance crisis.”

He also noted that weak productivity growth remains a challenge for the whole world and “much hope rests on artificial intelligence delivering strong productivity gains in the medium term”.

Time To Take The ‘E’ Out Of ESG Investing

The decision by the boss of DWS to step down is a wake-up call to the investment industry as environmental claims come under growing scrutiny.

It’s a slow start for 2024 but the longer term outlook for the local economy is strong