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Beyond the ESG hype: Towards a long term reality

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Many questions are being asked about ESG investing. Does it produce better returns? Can one rely on ESG data of any kind to decide where to invest? Does the recent poor performance of ESG investing herald a move to other foci? Is ESG tech the best bet? Is a target of net-zero realistic, or has it led to a lot of hype? The list goes on.

But are these the right questions? We believe not, and we are not the only ones.

ESG investing and the hype cycle

Anyone who has been involved in the world of business innovations will know that these are the wrong questions. Studies going back many years of how new approaches to business are born, led by Everett Rogers, spread and eventually become a normal part of reality for most businesses show how long the process takes – decades rather than years.

The innovations Rogers and many later researchers focused on were generally for the benefit of the organisations implementing the innovation, typically profit, saving cost, or even survival. However, today, with government and the third sector heavily involved in economic activity, the objectives of innovation have become much broader, with the focus often being on customers, citizens or even society as a whole.

There are many stages of adoption of an innovation (in this case ESG reporting). Typically, these stages start with potential users becoming aware of an innovation, being persuaded that it is worth doing (understanding its benefits and costs), deciding to do it, implementing it and continuing to use it.

But how do potential users become aware and understand? Here another factor comes into play, one that is particularly powerful in the age of the Internet. This is the extent to which users, potential users, consultants, governments etc. talk about the innovation (irrespective of what they are doing), perhaps hyping it up as having great benefits relative to costs, or as leaving organisations no choice but to use the approach. The recent surge of ESG coverage in the media indicates that this is happening with much greater frequency.

One tool used to analyse this surge and its consequences is Gartner’s Hype Cycle. This was originally used to describe the evolution of information technology markets. It describes situations where expectations about an innovation are inflated by publicity which focuses on successes and ignores failures.

Enter disillusionment

The above is followed by disillusionment, when many experiments and implementation fail to deliver, and a shake out of suppliers associated with the innovations takes place. However, this is followed by the slope of enlightenment, when there are many more examples of successful implementation which meet the needs of users. Finally comes a stage when mainstream adoption takes off, criteria for assessment of success are more clearly defined, and the innovation becomes part of “business as usual”.

Although some writers consider that ESG investing is now at the beginning of the slope of enlightenment, the recent panic about ESFG investment and the demonstrable very poor quality of ESG data seem to indicate that we are at a much earlier stage, when disillusionment is beginning to set in.

However, Gartner’s methodology is not designed to take account of the effect of regulation, which seems likely to force the pace of change, so that companies will not be able to choose whether or not to adopt the innovation of ESG reporting (and of course its much-desired companion, improved ESG behaviour/compliance).

This strong regulatory pressure will lead to many more hurried and botched implementations than would have been the case, and so more disillusionment. Shortage of the consulting, leadership and management skills required for ESG reporting is a particular problem, and organisation leaders agree. However, these issues will not change the long-term trend. However, it is also leading to a strong focus on ESG by fund managers, and in ESG investment in general.

Towards a long-term perspective

All this means that ESG reporting, ESG behaviour/compliance and ESG investing should be viewed with a much more balanced, long-term perspective. Fund managers seem to agree, given their focus on avoiding investing in firms that are not compliant with ESG standards.

Expecting the rapid emergence of perfect, internationally agreed standards and data is not realistic. Expecting organisations to be able to switch their behaviour quickly is not realistic either – most organisations simply do not know enough about their ESG impact to make realistic plans to change them.

What is certain, however, is that the focus on ESG issues is here to stay, because the focus represents what the most elected representatives in democratic societies see as an essential element of the contribution of organisations to society. Whether the central objective of an organisation is profit, meeting a charitable need, or providing a government service, most Western democracies are taking the view that organisations should no longer be run just by focusing on their central objective. They also need to focus on their contribution to society.

Recent events, such as Covid and the Ukraine War, have only served to accentuate this trend, while deeper analysis confirms the relationship between ESG focus and financial performance. That is why it is so useful to have a reliable source of ESG information that reflects reality rather than one that aspires to compliance with unagreed standards or complex reporting requirements.


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