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Aswath Damodaran says ESG investing will not make you money, it's a mistake

MUMBAI: Renowned academician Aswath Damodaran says the trend of ESG (environment, social and governance) investing that has caught on rapidly around the world would end up costing companies and investors dearly.

“I believe ESG is not just a mistake that will cost companies and investors money, while making the world worse off. It creates more harm than good for society,” Damodaran, professor of finance at Stern School of Business at New York University, wrote on his blog Musings on Markets late Tuesday.

ESG investing has been one of the defining investment trends of the 21st century with nearly $3 trillion of assets currently being managed under some form of ESG mandate or other by asset managers around the world. In India too, ESG investing has taken off in a major way over the past three years, with more mutual funds coming out with “ESG only” schemes to cater to the rising demand.

The Securities and Exchange Board of India (Sebi), taking note of the rising demand for more ESG-related disclosures, recently revamped the business responsibility reporting standards on issues such as environmental impact, social welfare and corporate governance by companies.

“Why is ESG being sold so aggressively? Because accountants, measurement services, fund managers and consultants are on the ESG gravy train, with stockholders and taxpayers paying. Corporate CEOs are buying into ESG, because it makes them accountable to no one,” Damodaran said.

The rising sway of ESG funds around the world has been driven by ‘millennials’ and ‘Generation Z’ investors, who want to invest in companies that are taking action on climate change and social welfare. The movement received a further push when some of the biggest names in finance came together to move towards stakeholders’ capitalism from shareholders’ capitalism.

Damodaran drew a parallel between the current wave of ESG investing to the corporate governance wave seen two decades ago in the aftermath of the Enron scandal. The Enron episode pushed proxy advisors, accountants and ruler writers to ask for more disclosures for companies in the name further enhancing shareholder power.

“The fact that the corporate governance movement only enriched services, consultants and bankers, but left shareholders more powerless than they were before the movement started, holding shares in companies with dual class shares or worse, should act as a warning for the advocates of ESG disclosure/measurement,” Damodaran said.

For investors who are gobbling up ESG funds in the hunt for higher returns that puts less burden on their social consciousness, Damodaran said if the market is over-enthused about ESG and is overpricing how much being “good” will add to a company’s profitability or reduce risk, then investing in ‘good’ companies will generate lower risk-adjusted returns than investing in ‘bad’ companies.

“If being good makes companies less risky, investors in good companies will earn lower returns than investors in bad companies, before adjusting for risk, and equivalent returns after adjusting for risk,” Damodaran said.

‘The Professor’, as many of his admirers call him, is part of a growing list of investors who are becoming increasingly skeptical of investment decisions that are giving too much weightage to what a company’s ESG score is, than to its fundamental intrinsic value.

“I am certainly not willing to concede, without challenge, that a corporate CEO knows my value system better than I do, as a shareholder, and is better positioned to make judgments on how much to give back to society, and to whom, than I am,” Damodaran said.