Practical analysis for investment professionals
28 January 2022

The Elephant in the Room: The ESG Contradiction

We all agree that finance has a key role to play in getting us to net zero. But we can’t ignore the elephant in the room: the inherent conflict between the “E,” the “S,” and the “G” in environmental, social, and governance (ESG) investing.

As much as we might wish otherwise, the goals embedded in these initials don’t always align with one another. That’s why a compromise must be made. Investors, asset managers, and businesses have to agree on which of the three is the most important.

So, what’s our position at SustainFinance? We believe social, the “S,” should be the highest priority. Why? Because sustainability is all about humanity.

The “S” factor is broad. It varies by country, culture, and context. Figuring out how these can be lined up within the boundaries of net-zero goals must come down to people.

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Someone Ultimately Has to Pay.

Convincing manufacturers on tight margins to spend money to cut their greenhouse gas emissions is an enormous challenge. It comes with consequences.

Let’s make this real: A healthy environment, a living wage, and strong workers’ rights cost money. Clients want these outcomes, but at a reasonable price. The same goes for investors. They want their money channeled to good companies that treat their workers well. And they want good investment returns. But at the end of the day, none of this is free.

To reduce emissions, companies may have to sacrifice the profits they pay out as dividends to shareholders. At least at first. And with falling dividends come falling share prices, and both hurt the returns of those saving for retirement or for their children’s education.

This means we have to align multiple interests. Investors, asset managers and businesses are ultimately all about people. So we have to shift our thinking away from a focus on environmental issues in isolation and towards a more holistic approach that looks at outcomes from a broad social perspective.

In a post-pandemic world, this reset has huge ramifications.

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Investors Want Returns.

When it comes to future liabilities — retirement, education, etc. — the pressure is on investors to achieve their required returns.

Their usual focus is on accumulation or income generation. This drives the prices of the assets being sought. Those seeking income to fund their retirements will chase high-dividend paying companies, especially in the current low interest-rate environment.

In Asia, many companies pay out much of their profits as dividends. If they reduce profits, and therefore dividend payments, to invest in greening their businesses, the market will punish them. Investors focused on income stocks will take their money elsewhere.

Part of the sustainability challenge is that the highest dividend companies are often in traditional, asset-heavy industries with large carbon footprints. To support them in their net-zero transition, investors will have to accept lower dividend payouts, otherwise these companies won’t survive the move to low carbon alternatives. While this green transition is desirable over the long term, in the short term it will create unmanageable economic dislocation.

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The major challenge for the asset management industry is the saturated, highly competitive market in which it operates.

Fund managers are traditionally judged on performance. Now, however, their ability to incorporate ESG factors is another area of competitive pressure. How do they maintain performance while also meeting expectations around ESG?

Yes, ESG strategies outperformed in 2020, and demonstrated that sustainability can generate returns. But digging deeper, the data indicates that positively screened ESG companies have lower employee metrics and tend to be asset-light industries. Automation does not create jobs and white collar tech workers don’t need the same protections as those on an assembly line.

Investing in large ESG-positive businesses also has a destructive effect. It channels money away from asset-heavy and job-creating industries that support local communities. And what about small and medium-sized enterprises (SMEs) that score low on ESG and need to finance their net-zero transition? Is the market punishing or helping them?

Businesses Are at the Sharp End.

Companies must tread a fine line. They must keep their business profitable in the near term while investing in going green over the long term. Sustainability is no longer a nice-to-have accessory, it is a way to future-proof their business.

But delivering on the “E” is expensive. If the cost cannot be passed on to the end customer, it will have to come out of the business, whether in staff salaries, bonuses, or head count. It may also render certain functions — and jobs — obsolete. The “E” comes at the expense of the “S.”

In Asia, the objective used to be squeezing the last drop of profit out of the business. Now it is slowly shifting to longevity and legacy. Paying out all profits in dividends is short-sighted, while playing the long game may increase margins over time. To accomplish this, companies need the right investors.

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What’s Next?

Stakeholders have to dispense with the quarterly mindset and build longer-term relationships and expectations. They need to move away from get-rich-quick investing.

Generating returns and being true to the “S” takes time. Short-termism is the antithesis of sustainable growth. For companies to meet the net-zero challenge, they need investors who understand what’s at stake and what it will take to achieve.

Now is the time to acknowledge the elephant in the room and start making that mindset shift. And that means embracing the S in ESG.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©Getty Images / tiero

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About the Author(s)
Andrea Webster

Andrea Webster is a managing director at Chartwell Capital and a contributor at SustainFinance. With over 20 years' experience in the wealth and asset management industry, she has spent over a decade working with boutique asset managers on business expansion.

Paul Smith, CFA

Paul Smith, CFA, is the founder of SustainFinance and the former president and CEO of CFA Institute. He has more than 25 years of relevant financial services leadership experience in many aspects of the investment management industry.

Kübra Koldemir

Kübra Koldemir is a sustainability business writer at SustainFinance as well as a sustainability researcher at Argüden Governance Academy. She has written numerous sustainability articles that have been published at various global publications. Koldemir started her financial career in 2006 working as an investment analyst in New York City, first at a long-only fund and later at a hedge fund with $1 billion in assets under management (AUM) that specialized in financial service companies. With a focus on international investments, she assessed strategy and results of numerous multinational corporations across several sectors. Koldemir holds a BA in international relations from Mount Holyoke College and an executive MBA degree from the University of Texas at Austin.

9 thoughts on “The Elephant in the Room: The ESG Contradiction”

  1. Mille says:

    Very pertinent.

    We must even further investigate what are the reasons of our current collectif behaviors.
    Continue the work.

    We are we so slow.
    What did we learn in 50 years since 1972 and the “Limits to growth” conclusions.
    Do we need yet 50 years to change our mindset as it was written 50 years ago ?.
    May be.

    Do we have time.

  2. Kevin R. says:

    Wow… what a down to earth revealing article. Thank you. I have always struggled personally with ESG investing since this “fad” came into mainstream. I’m a “show me the technicals” type of investor. Huge conflicts as you so appropriately point out throughout your article. But yet, the mantra continues. One of the best lines in your article is: “Someone ultimately has to pay.” Many other truths you point out, but this one stood out in my mind. To add one more…. “You can’t have your cake and eat it too!” Kudos!

  3. Musaab Mousa says:

    Nice article, but what about G?

  4. Stephen W. Shipman, CFA says:

    ESG may be an option IF there is really a desired outcome of what they call ‘net zero’. (Meaning, of course, the green and globalist politicians’ objective of ZERO net CO2 emissions by 2030 or 2050). Yet, the authors preposterously assume that a) anthropomorphic contributions of CO2 are excusively influential in ‘climate change,’ and b) that society and economies can actually control climate outcomes. They will cite scientific ‘consensus’, but honest observers know that there are serious scientific and empirically validated critiques of the so-called consensus. That the Institute has allowed itself to be captured by the globalists’ political agenda is appalling. What is worse, neither the Board nor management has promoted a serious debate of both sides the climate question. This is a typical modus operandi of the pseudo-scientific elites: under no circumstances, hold a debate to discern true measured impacts from policies that little underlying certainty. (Look at the incredible fiasco they created with Covid)! They especially avoid debates with those who will undermine the thin reed of argument on which their ‘net zero’ target sits.

    For members who are actually acute and intellectually curious to find such debate and criticism, I recommend visiting the resources at, which has been around for decades and whose many contributors are truly anchored in science, not politics or sentiment.

    Finally, the narrative steamroller of ESG at CFAI, including both articles like this and the recently announced credentialling program, as well as the recent DEI initiative as a sister narrative of the globalist elites, call into question when and how the Institute has been captured by the interests that stand to benefit from promoting these narratives. Heretofore, the Institute strove to improve the transparency and integrity of SHAREHOLDER capitalism. Now, without extensive debate and discussion (across ALL GLOBAL SOCIETIES), the Institute, in large part at the initiative of Mr. Smith, has embraced STAKEHOLDER capitalism (some would suggest CRONY capitalism). My guess is his masters in Europe are quite pleased.

  5. Rehab Abdellatif says:

    “net ZERO” needs deep change in the entire human activities on all levels. Meaningful starting piont IS, are we ready to take that change and accept new patern of life including different rate of return or we just want to compromise to buy time hoping that the problome will solve itself.

  6. Kashyap Swamy says:

    This is a disappointing piece of analysis. Some notable misses:

    1. The article claims “.. channels money away from asset-heavy and job-creating industries that support local communities.”

    Sustainable investing remains an art and surely part of the art is to be able to apply best-in-class metrics in each industry rather than apply the same metrics in asset-light and asset-heavy industries. Further, the incremental investment routed to renewable energy and sustainable industries creates new jobs.

    2. The article downplays the importance of “E” . Large universal asset owners have emphasized the importance of addressing factors like climate change, which were previously considered externalities, in increasing portfolio returns and reducing risks. The costs from the increasing frequency of climate change-related disasters such as forest fires is well-documented.

  7. Jasper Veel, CFA says:

    I find this a very odd analysis.

    The article rightfully states that there might be conflicting stakeholder and shareholder interests. But what is the so called conflict between ‘E’, ‘S’ and ‘G’?

    Balancing stakeholder interests/expectations is at the core of strategic decision making, which is all about Corporate Governance (the ‘G’).

    Companies should have adequate Corporate Governance structures and practices to balance the various conflicting interests and expectations. There is no conflict between ‘E’, ‘S’ and ‘G’, there is a prioritization challenge, which requires strong CG practices and a thorough understanding of conflicting expectations and requirements.

  8. Kyle Jones says:

    Rather than critique the major points of this article, I’m going to briefly address a small, but important point made towards the end of the article. Specifically, the authors state “Yes, ESG strategies outperformed in 2020, and demonstrated that sustainability can generate returns.”.

    This claim isn’t new, and the authors aren’t in the minority in making it as there has been an abundance of average research supporting this claim. However, much more rigorous research suggests otherwise. Much of this “alternative theory” line of work lends support to the view that growth outperformed, not ESG (for instance, see Nicolas Rabener in this very blog with his piece titled “ESG Investing: Too Good to Be True” published in January 2019). In a fairly recent paper in the Journal of Business, Finance, and Accounting, Bemers, Hendrikse, Joos, and Lev found that, rather than just growth, it was firms that invested heavily in intangibles were the ones which were able to outperform during the early days of the pandemic (ESG did not immunize stocks during the COVID-19 crisis, but investments in intangibles did, JBFA, February 2021, 433-462).

    As if this isn’t enough of a criticism, ESG has been presented as an investment panacea – screen for the firms with high ESG scores and you can’t fail. Yet, since fall of 2020, those very same high ESG stocks have underperformed, beat out by those filthy sin stocks that so many now days seem to want to disappear from the earth forever.

    I can only speak for myself, but when I invest my money, I want high returns so as eventually be able to provide for myself in retirement. If society decides that maintaining a low carbon footprint is what it desires, then fine, legislate the criteria which firms must follow. Otherwise, let firms do what they do best, produce products and services that consumers desire and maximize return to shareholders in process.

  9. Environmental, social, and corporate governance investing is a decision-making process concerning the purchase, sale and management of an asset or assets selected with the goal of attaining an increase in value over a period of time. ESG investing considers three factors as an explicit part of the management, selection and evaluation process. Yes, we saw the industry selection impacts come to the fore when we created diversity investing in 2006 upon the realization that a diverse corporation has an inclusive workforce, marketplace and business community (suppliers, partners and investors).

    One key finding of our research is that individual, singular environmental, social and governance issues and concerns are irrelevant. These change rapidly, so focusing on any one sector (E, S or G) is not relevant to general principles. This is where most ESG policy efforts fail.

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