Insurmountable challenge or acceptable evolution? A history of ESG

The origins of ESG can be found in the early 17^th century when questions were raised about corporate governance in the Dutch East India Company. But it is only in recent years we have prioritised scrutiny on the practices of ESG evaluation and screening methodologies. AlTi’s Chief Impact Officer Jed Emerson explains where we have come from – and why, despite the challenges, we are headed in the right direction.

You may think of ESG as a relatively new concept – an investment approach that has gained traction over the past decade amid increasing concern for the survival of our planet.

Yet, discussions of extra-financial value – aspects of capitalism beyond our financial accounting and balance sheets – have been with us since the start of capitalism itself, in the early 17th century. History shows us ESG (environmental, social and governance) has long been considered by investors and has evolved over many centuries to get to where we are today.

We can first trace ESG concerns back to 1608, with the return of the first expedition financed via shareholder investments. Questions were raised concerning the governance and social shortcomings of the Dutch East India Company, with lawsuits filed claiming fiduciary breach and shares being divested in the name of moral commitments and values.

Decades later, Mennonites and orders within Catholic traditions began managing wealth based on screening out ‘bad’ companies they felt violated fundamental principles of the Church and ethics. And later, with the advent of the Vietnam War, the defence industry and firearms were added to the list of exclusions. 

In the 1970s, the Republican-led creation of the Environmental Protection Agency meant US-based investors could, for the first time, access data on corporate environmental performance and bring those numbers into their calculation of value and estimation of risk.

By the 1980s, the practices of good governance, transparency and sound accounting were woven in to give us what was initially referred to as socially responsible investing. This then progressed to environmental, social and governance investing, the positive screens and negative tilts of ESG.

More recently, this work has evolved to become ESG integration investing, wherein ESG issues are explicitly included within overall investment analysis and decisions not to function as a screen but rather to ‘crowd in’ additional data for investors to assess off balance sheet risks—to understand how factors such as climate crisis or social inequity might affect financial returns.

While many now accept the reality that ESG factors are material to financial performance, it is no wonder today, with trillions of dollars claiming to be supporting more than financial value and returns alone, there is a level of confusion and questioning regarding whether any of these discussions and all this great effort matter.

Newcomers, and even some in leadership positions within firms promoting present ESG investment practices, shout foul when they discover their investment vehicle carries less positive good than they had presumed or been sold. They may be surprised to discover their investments are more focused on how external aspects of the environmental crisis and social inequity will affect the financial performance of companies and their ability to generate sustained profit.

That said, ESG was never meant to create a more just society and to advance positive impact in the world. Its initial aim was to protect companies and investors from the creeping advance of off-balance-sheet risk of climate crisis and, to a lesser degree, social inequity.

The first question sceptics asked in the 1970s and 1980s was: 

“How much financial return must I sacrifice in order to do good?”

And the answer they heard was: “None. This is not about some vague notion of “do-gooding,” but rather a consideration of how these factors are material to the generation of ‘competitive’ financial returns. Let us prove that they are…”

And so, for a couple of decades, we were off to the materiality races, demonstrating we could invest with consideration of ESG factors while generating competitive financial returns.  

Today, as millions of investors continue their journey along this path, we now place growing scrutiny upon the actual practices of ESG evaluation and screening methodologies, asking questions such as:

• How do we best measure these elements?
• What is their worth?
• Which are most relevant to the financial performance of the firm – and is that even the right question to be asking? 

This is exactly as it should be. ESG practices should continue to be scrutinised. This is the very same process our metrics of traditional finance have undergone over the years, so why should the journey of ESG investing be any different?

After all, it was not until after the financial disaster of the Great Depression that the Generally Accepted Accounting Principles (GAAP) were created in the US, and much later still, in 1973, that the Financial Accounting Standards Board (FASB) was born. Both are the frameworks we now embrace to track mainstream, traditional finance and investing worldwide.

At AlTi, we are constantly assessing and evaluating how we can support positive change. ESG evaluation is embedded throughout the investment process, and ESG and impact reporting is fully integrated into impact client portfolio reporting, and will be available for all clients by the end of the year. As an example, in our US Wealth Management practice, we are proud to say we invested $4.1bn in impact strategies as of March 31, 2023, and expect to invest a further $25bn by 2030.

Modern approaches to tracking and assessing the performance of off-balance-sheet risk in the form of environmental, social and governance factors are only a few decades old, largely driven by the private non-profit and business sectors. It is timely and appropriate that our approaches to ESG are under near-constant evolution and refinement. We are drawing upon the traditions, wisdom, and experience of previous generations, just as we hope future generations will draw on what we are offering.

It has taken us centuries to get where we are today, and we will continue to see ESG scrutiny evolve over coming years. When viewed in the flow of history, the ESG challenges of today are not an immovable rock creating obstacles for fund managers and investors. They are more a pebble-sized irritant to be acknowledged, set aside, and transcended as we continue along our way.

Hard to handle? Of course. Insurmountable challenge? Certainly not.