History
Investment decisions are predominantly based on the potential for financial returns for a given level of risk.[10] However, there have always been many other criteria for deciding where to place money—from political considerations to heavenly reward.
In the 1970s, the worldwide abhorrence of the apartheid regime in South Africa led to one of the most renowned examples of selective disinvestment along ethical lines. As a response to a growing call for sanctions against the regime, the Reverend Leon Sullivan, a board member of General Motors in the United States, drew up a Code of Conduct in 1977 for practising business with South Africa.[11] What became known as the Sullivan Principles (Sullivan Code) attracted a great deal of attention. Several reports were commissioned by the government to examine how many US companies were investing in South African businesses that were contravening the Sullivan Code. The conclusions of the reports led to mass disinvestment by the US from many South African companies. The resulting pressure applied to the South African regime by its business community added great weight to the growing impetus for the system of apartheid to be abandoned.[12]
In the 1960s and 1970s, the economist Milton Friedman, in response to the prevailing mood of philanthropy, argued that social responsibility adversely affects a firm's financial performance and that regulation and interference from "big government" will always damage the macro economy.[13] His contention that the valuation of a company or asset should be predicated almost exclusively on the financial bottom line (with the costs incurred by social responsibility being deemed non-essential) was prevalent for most of the 20th century (see Friedman doctrine). Towards the end of the 20th century, however, a contrary theory began to gain ground. In 1988 James S. Coleman wrote an article in the American Journal of Sociology titled "Social Capital in the Creation of Human Capital", the article challenged the dominance of the concept of 'self-interest' in economics and introduced the concept of social capital into the measurement of value.[10]
There was a new form of pressure applied, acting in a coalition with environmental groups: using the leveraging power of collective investors to encourage companies and capital markets to incorporate environmental and social risks and opportunities into their decision-making.
Although the concept of selective investment was not a new one, with the demand side of the investment market having a long history of those wishing to control the effects of their investments, what began to develop at the turn of the 21st century was a response from the supply-side of the equation. At the time, this field was typically referred to as ethical or socially responsible investment. The investment market began to pick up on the growing need for products geared towards what was becoming known as the Responsible Investor. In 1981, Freer Spreckley, the creator of Social Enterprise, published Social Audit — A Management Tool for Co-operative Working, in which he first introduced the idea of a set of internal criteria that social enterprises and other organisations should use in their annual planning and accounting. These were financial viability, social wealth creation, organisational governance, and environmental responsibility, and they became known as social accounting and auditing. Later on, in 1998, John Elkington, co-founder of the business consultancy Sustainability, published Cannibals with Forks: the Triple Bottom Line of 21st Century Business, in which he identified the newly emerging cluster of non-financial considerations that should be included in the factors determining a company or equity's value. He coined the phrase the "triple bottom line", referring to the financial, environmental, and social factors included in the new calculation.[14][15] At the same time, the strict division between the environmental sector and the financial sector began to break down. In the City of London in 2002, Chris Yates-Smith, a member of the international panel chosen to oversee the technical construction, accreditation, and distribution of the Organic Production Standard and founder of a branding consultancy, established one of the first environmental finance research groups. The informal group of financial leaders, city lawyers, and environmental stewardship
In the early years of the new millennium, the major part of the investment market still accepted the historical assumption that ethically directed investments were by their nature likely to hinder financial returns. Philanthropy was not considered to aid profitable business, and Friedman had provided a widely accepted academic basis for the argument that the costs of behaving in an ethically responsible manner would outweigh the benefits. However, the assumptions were beginning to be fundamentally challenged. In 1998 two journalists, Robert Levering and Milton, brought out the "Fortune 100 Best Companies to Work For", initially a listing in the magazine Fortune, then a book compiling a list of the best-practicing companies in the United States with regard to corporate social responsibility and how their financial performance fared as a result. Of the three areas of concern that ESG represented, the environmental and social had received most of the public and media attention, not least because of the growing fears concerning climate change. Moskowitz brought the spotlight onto the corporate governance aspect of responsible investment. His analysis concerned how the companies were managed, what the stockholder relationships were, and how the employees were treated. He argued that improving corporate governance procedures did not damage financial performance; on the contrary, it maximized productivity, ensured corporate efficiency, and led to the sourcing and utilizing of superior management talents. In the early 2000s, the success of Moskowitz's list and its effect on companies' ease of recruitment and brand reputation began to challenge the historical assumptions regarding the financial effect of ESG factors.[16] In 2011, Alex Edmans, a finance professor at Wharton, published a paper in the Journal of Financial Economics showing that the "100 Best Companies to Work For" outperformed their peers in terms of stock returns by 2–3% a year over 1984–2009, and delivered earnings that systematically exceeded analyst expectations.[17]
In 2005, the United Nations Environment Programme Finance Initiative commissioned a report from the international law firm Freshfields Bruckhaus Deringer on the interpretation of the law with respect to investors and ESG issues. The Freshfields report concluded that not only was it permissible for investment companies to integrate ESG issues into investment analysis, but it was also arguably part of their fiduciary duty to do so.[18][19] In 2014, the Law Commission (England and Wales) confirmed that there was no bar on pension trustees and others from taking account of ESG factors when making investment decisions.[20]
Where Friedman had provided academic support for the argument that the integration of ESG type factors into financial practice would reduce financial performance, numerous reports began to appear in the early years of the century that provided research that supported arguments to the contrary.[21] In 2006 Oxford University's Michael Barnett and New York University's Robert Salomon published an influential study which concluded that the two sides of the argument might even be complementary—they propounded a relationship between social responsibility and financial performance. Both selective investment practices and non-selective ones could maximise the financial performance of an investment portfolio, and the only route likely to damage performance was a middle way of selective investment.[22] Besides the large investment companies and banks taking an interest in matters ESG, an array of investment companies specifically dealing with responsible investment and ESG based portfolios began to spring up throughout the financial world.
Many in the investment industry believe the development of ESG factors as considerations in investment analysis to be inevitable.[23] The evidence toward a relationship between consideration for ESG issues and financial performance is becoming greater and the combination of fiduciary duty and a wide recognition of the necessity of the sustainability of investments in the long term has meant that environmental social and corporate governance concerns are now becoming increasingly important in the investment market.[24] In addition, surveys of ultimate beneficiaries (on whose behalf savings and pensions are made) typically show high levels of support for considering social and environmental issues alongside long-run, risk-adjusted returns.[6] ESG has become less a question of philanthropy than practicality.
There has been uncertainty and debate as to what to call the inclusion of intangible factors relating to the sustainability and ethical effectiveness of investments. Names have ranged from the early use of buzz words such as "green" and "eco", to the wide array of possible descriptions for the types of investment analysis—"responsible investment", "socially responsible investment" (SRI),[25] "ethical", "extra-financial", "long horizon investment" (LHI), "enhanced business", "corporate health", "non-traditional", and others. But the predominance of the term ESG has now become fairly widely accepted. A survey of 350 global investment professionals conducted by Axa Investment Managers and AQ Research in 2008 concluded the vast majority of professionals preferred the term ESG to describe such data.[26]
In January 2016, the PRI, UNEP FI and The Generation Foundation launched a three-year project to end the debate on whether fiduciary duty is a legitimate barrier to the integration of environmental, social, and governance issues in investment practice and decision-making.[27]
This follows the publication in September 2015 of Fiduciary Duty in the 21st Century by the PRI, UNEP FI, UNEP Inquiry and UN Global Compact.[28] The report concluded that "Failing to consider all long-term investment value drivers, including ESG issues, is a failure of fiduciary duty". It also acknowledged that despite significant progress, many investors have yet to fully integrate ESG issues into their investment decision-making processes. In 2021, several organizations were working to make ESG compliance a better understood process in order to establish standards between rating agencies, amongst industries, and across jurisdictions. This included companies like Workiva working from a technology tool standpoint; agencies like the Task Force on Climate-related Financial Disclosures (TCFD) developing common themes in certain industries; and governmental regulations like the EU's 2019 Sustainable Finance Disclosure Regulation (SFDR).[29][30][31][32]
During the COVID-19 pandemic, BlackRock, Fidelity, and Amundi among other asset management companies, placed pressure on pharmaceutical companies in which they had a large stake to cooperate with each other.[33]
In late 2022, Leonard Leo and associated networks launched a campaign to dismantle ESG, with special targeting on climate-friendly investment. Consumers' Research and Republican attorneys general announced investigations into The Vanguard Group.[34] Vanguard announced in early 2023 that it was quitting the Net Zero Asset Managers Alliance and would distance itself from ESG investing altogether as something, according to its CEO, that's not compatible with its fiduciary duties to the investors. Its CEO told the Financial Times that "Our research indicates that ESG investing does not have any advantage over broad-based investing." While most ESG fund managers promise to beat broad indexes, fewer than 1 in 7 of their active equity managers outperformed the broad market in any five-year period and none of them relied exclusively on a net-zero investment methodology.[35]
In 2026, Vanguard paid $29.5 million to settle a lawsuit brought by multiple attorneys general for allegedly conspiring with BlackRock and State Street to use ESG initiatives to manipulate coal markets.[36][37][38]
