ESG v sustainability: are we heading in the right direction?

Mar 7, 2024 | Member Blog

A professional woman sitting at a conference table, appearing attentive.
Lorna Kennedy
Client Relationship Director, Partner. 

As with any investment, capital is at risk.

Late at night, a police officer finds a man crawling around under a streetlight. The man tells the officer he is looking for his wallet, which he’d dropped across the road.

“Why are you looking over here?” asks the officer, to which the man replies: “Because the light’s better.”

In some ways, this is analogous to our industry’s current approach to environmental, social and governance (ESG) issues.

As the appetite for sustainability is growing among defined contribution (DC) members, it is important to question: are we focusing our efforts where it’s easiest to take metrics, rather than where our actions could be most valuable?

Opaque definitions

Observing good practices goes to the heart of a business’s operations, encompassing how it treats the environment, manages its employees, and upholds human rights.

If companies are under pressure to achieve certain data points, they may focus on factors that improve their ESG scores but make little real-world impact.

It doesn’t help that definitions of ESG are inconsistent. This makes it difficult to compare different organisations’ performance.

Several studies have found little correlation between the ESG scores that different data providers give to the same companies. That’s because they evaluate different attributes using different measurement indicators.

This can lead to some surprising results. For example, according to one ratings agency, British American Tobacco has a higher ESG score than wind turbine company Vestas.

Joining the dots

How can we resolve the discrepancy? For some, the answer is to standardise ESG reporting, making it mandatory and pushing for more data analysis. Regulators seem to agree.

However, we believe emphasising quantitative scoring disregards the complexity of the issues it claims to address.

Our answer is to think about companies holistically and look not just at their long-term potential but also at the impacts they have on the broader system. Can they reduce emissions, benefit communities or lead to improved governance?

Integrating ESG with investment research, placing emphasis on qualitative factors and exploring hypothetical scenarios to anticipate change should also lead to better decisions than relying solely on numerical data.

It helps to have a longer time horizon too. By engaging with company management over time, investors can build influence.

The right direction

Our proposed approach to ESG is resource intensive, but we think it’s worthwhile.

Certainly, it would be easier to look where the light’s better and rely on third-party data. But instead, we believe the right direction takes us towards in-depth qualitative measuring.

The reward is opportunity. Consider the energy transition or advances in healthcare. At their core, these sectors should propagate sustainability and positive social outcomes.

To help companies achieve their potential, address global issues, and deliver long-term growth, investors must go further than simple data analysis.

This communication was produced and approved in March 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

This article does not constitute, and is not subject to the protections afforded to, independent research. Baillie Gifford and its staff may have dealt in the investments concerned. The views expressed are not statements of fact and should not be considered as advice or a recommendation to buy, sell or hold a particular investment.

Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA).

The asset managers that make up the DCIF are committed to promoting investment best practice within DC pension schemes.