Clarifying the Many Misconceptions About ESG

It's neither ESG is data, it's material, non financial considerations that can have a long term financial impact on a company, and therefore should really be considered within the investment decision making process. So it's not an investment approach, it's data. And how this data is used depends on what your clients objectives are, your client might want pure financial outcomes, or they want might want more mission driven outcomes, like changing the world that would align with an impact strategy. But classic ESG integration, that's using ESG that's environmental, social and governance factors, to get a more holistic view of risk and opportunity in a portfolio that supports risk mitigation and long term risk adjusted returns that aligns with ESG integration, pure financial, to more mission driven changing the world, that would be an impact strategy.

The second misconception is that ESG is somehow politically driven. And I'm here to tell you, there is no p and E S, G. So I think that people who are critics or even detractors of ESG, when they hear it or think about it, they're thinking about hard exclusions, like excluding fossil fuels, which may be a mainstay of their communities and their economies. And it's not that at all that is just one ESG approach. You can have ESG integration, as I said before, you can have impact for those clients that want to change the world. You can have thematic strategies for clients who care about a certain trend like clean water or decarbonisation, or gender equity.

So the exclusions are just one tiny slice. And there's another myth that goes along with that, that if you are excluding fossil fuel companies, you're somehow starving that sector of capital. That is not the case. If you divest a fossil fuel company, someone else is on the other side of that trade, and they're going to own that company, you're not really making progress towards decarbonisation. I say at federated Hermes, we are about engagement versus divestment.

We might own these brown industries, and then actively engage with them, to help them mitigate looming risks, whether it's regulatory or social, we will help them to decarbonize which of course, is a very, very long term prospect, but you've got to be in it in order to exercise your shareholder rights.

And the last myth is that ESG investing is dead because of the underperformance in the first quarter of 2022.

There was such crowded trade around over owning big cap tech stocks, because they have few hard assets and so they get better ESG ratings and then not owning the fossil fuel companies. So fossil fuel companies, of course, had been on fire as as as commodity prices have been bid up in the wake of the Russia, Ukraine conflict, and big cap tech that has just really taken a nosedive. And so those crowded trades, which are positive screening strategies, more of the the less active strategies will simply own those companies with the best ESG scores and disowned companies with the worst. They underperformed. So this is a short term phenomenon. Does ESG work every time? No. Does it work over time? Yes, it does.