The anti-environmental, social and governance (ESG) movement championed through parts of the US and beyond in recent months has cast the incorporation of ESG factors into investment decision-making as a political agenda rather than a financial discipline. Its narrative – that considering ESG factors detracts from investment performance, introduces red tape, and is an unnecessary constraint on free markets – makes for good headlines. However, it distracts from the fundamental point of investment management principles, one that is worth re-emphasising; considering ESG factors in the investment process is built on the investment principle of risk management.

Considering ESG factors is not about ideology, it is about practical risk mitigation. As such, the dismissal of ESG as a core investment principle should not be viewed as a stand against politics or left-leaning policies, but rather as an act of discounting the risks that can negatively impact the underlying value of assets.

ESG is due diligence

The narrative that the consideration of ESG factors compromises the maximisation of returns is, quite simply, false. To maximise returns, management of downside risk must be factored into the investment process. Asset managers have a fiduciary responsibility to analyse and understand what is financially material to the companies that they invest in. Investors do not analyse governance failures, supply chain risks, or climate exposure because they want to signal virtue. They do it because of the risk that these factors pose to the underlying asset value.

To understand why anti-ESG sentiment has ramped up the way it has over the past few years, we need to look beyond the rhetoric and understand that ESG investment is not an alternative investment approach around which proponents of anti-ESG frame their argument. Investing is generally understood as putting “money” into an asset with the expectation of capital appreciation, dividends, and/or interest earnings. Considering material ESG factors as part of the investment process, which either detract or enhance the underlying value of an asset, provides a greater prospect of the asset meeting the expectation of a future return on investment.

As the world is evolving, we cannot only rely on how classic investment theory measures wealth. The dominant yardstick globally has been gross domestic product (GDP). Yet GDP fails to capture the true cost of externalities. This gap means that long-term systemic risks such as climate, social inequality and health are not adequately reflected in investment return models. As long as negative externalities remain mispriced, the concept of risk-adjusted return is fundamentally weakened.

The difficulty with externalities lies precisely in their nature: they are external, and as such, unpriced. Take the example of a company selling products that contribute to widespread ill health. Because the related healthcare costs are not directly priced into the product, the company is able to profit, while society bears the burden. Over time, however, the economic system responds – whether through healthcare providers, insurers, or governments – by internalising these costs. At that point, mechanisms such as taxes, regulations, or restricted market access begin to reflect the risk.

Considering the impact of externalities at a company level, Steinhoff did not collapse because it was “too ESG”, Tongaat Hulett did not implode because of “woke accounting”, and BHP did not attract material legal liabilities because of progressive politics. These disasters stemmed from ignored environmental, social, governance, and operational risks, the very territory ESG integration into investment decisions seeks to map and manage.

Beyond the rhetoric, the world is moving on

While US politicians continue their campaign against ESG, the rest of the world is moving decisively in the opposite direction. The European Union is embedding disclosure requirements, Asian regulators are tightening standards, and global supply chains are aligning to sustainability expectations. Multinationals accept that competitive advantage in the next decade will rest on resilience to manage ESG risks and opportunities appropriately, whether politicians admit it or not.

Reflecting on where we are as a responsible asset manager in respect of our climate change commitment, we recently analysed our top 50 companies by market capitalisation, including our top emitters, and noted that they have generally shown positive progress in their commitments to achieving net zero or at least carbon neutrality by 2050 or sooner. Geopolitics and the challenging economic conditions in our local market could have tempered these companies’ commitments towards climate action, yet their net zero strategies remain on track. As at the end of 2024, we had engaged almost every one of the top 10 greenhouse gas (GHG) emitters in South Africa, including Eskom. Of the top 50 listed companies:

• Only nine companies have yet to set long-term (carbon neutrality and net zero) targets.
• Two of those nine companies, Remgro and KAP, are in the process of approving long-term targets.
• Northam Platinum, while not yet committing to a long-term target, has committed to reducing the quantum of GHG emissions by 27% and the intensity by 60% by 2030, against a 2019 baseline.
• We have held engagements with 82% of these companies on their climate commitments and net zero.
  

Do not confuse politics with investing

Despite the political noise created by the anti-ESG rhetoric, investors should never lose sight of the fact that incorporating ESG metrics into investment decisions is not about enacting ideological values, it is about protecting value. It is about recognising that governance failures, social fractures and environmental shocks are not abstract risks but clear, material threats to portfolios – externalities that need to be considered, engaged with and priced in.

Drowning out this market imperative will come at a price, where least expected and where it matters most – in returns.