How ESG bans are threatening impact investing

Impact investors are being negatively affected by state bans on environmental, social, and governance (ESG)-themed strategies, according to consultancy group NorthPeak Advisory.

The London, UK-based firm said broad-brush approaches and misunderstandings had led to the new rules being “very likely to restrict impact investing” approaches that involve some degree of sacrifice on returns to achieve a positive impact.

Benjamin Stone, analyst at NorthPeak, said in a blog post that ESG integration for asset managers was separate from impact investing as it did not come at the expense of performance. However, “the way in which these two terms have been conflated may inadvertently affect asset managers who explicitly state they are accounting for ESG factors during the investment process”.

States including Texas and West Virginia have enacted legislation blacklisting some companies that have ESG policies that involve divesting from fossil fuel companies.

Others have brought in similar legislation affecting organizations that divest from firearms companies, while states such as Florida, Minnesota and North Dakota have broader rules banning ESG and similar investing strategies.

However, Stone argued that ESG investment “does not preclude any investment”, adding that “we can dispel the notion that the consideration of material ESG factors is somehow completely incompatible to generating financial returns”, as implied by many of the pieces of legislation enacted in recent months.

“It is unfortunate that how ESG factors are used in the investment process has been transformed into such a political topic and now sits at the forefront of the culture war in the US,” Stone wrote. “Importantly, the integration of ESG factors in the investment process is by no means perfect, but it is simply not how these states have described it to be.”

“I hope there comes a point where this particular debate shifts towards further transparency, improved data quality, innovation across asset classes and investment strategies, impact quantification etc, all of which is much more meaningful than driving political agendas and debating the basics.”

Stone urged asset managers to ensure their communications, both internal and external, are clear regarding ESG policies and factors. He also encouraged the formalization of ESG considerations, and called for asset managers to collaborate with peers and industry bodies to promote ESG investing.