The past three years have seen a surge of investment in environmental, social and governance (ESG) funds and the launch of many new ESG-labelled products. However, criticism of the movement took off in 2022. The Ukraine war exposed the economic dangers of the drive to renewables, while concerns over greenwashing, the threat posed to the defence industry and underperformance added to the critique facing ESG. In the US, ESG is also increasingly controversial from a political standpoint.
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Why ESG is facing a backlash after entering the mainstream
Ukraine war triggers criticism of ESG
ESG concerns have moved from being a fringe concern into the mainstream during this decade. In a report published in autumn 2022, PwC argued that ‘as ESG mandates fast become the default – not just in Europe but the US – the race is on to shift allocations and retrofit existing funds to keep pace with investor expectations’. 1
Global ESG AUM has exploded in recent years
Yet even as PwC’s ‘Exponential Expectations for ESG’ report hit the press, an anti-ESG backlash was gathering steam, creating ‘big headaches for some of the most powerful corporate leaders’, according to the Financial Times. 2
Criticism of ESG began following Russia’s invasion of Ukraine in February 2022. As energy supply shortages hit economies, and stocks reliant on fossil fuels outperformed, some began to question the wisdom of the drive to renewable energy. In May 2022, for example, the asset manager BlackRock – which has launched dozens of ESG funds in recent years – suggested ‘some short-term boost to fossil-fuel output was required despite its broad support for net zero objectives’, according to a Financial Times report. 3
Meanwhile, European governments scrambled to find alternative fossil fuels to shift away from Russian gas. Germany, for example, imported 44.4 million tons of coal in 2022, an 8% increase from the previous year. The country also brought around a dozen coal plants back onstream and extended the lifespan of several that were meant to be shuttered. 4
ESG has come under further criticism for excluding or heavily restricting investment in defence companies on ethical grounds. That undermines the ability of democracies to defend themselves, the argument goes. There’s also a case that a distinction should be made between weapons used for defence and those amassed for attacks. The higher defence spending initiated by the Ukraine war also means that investors are potentially missing out on opportunities for outperformance. The asset manager SEB Investment Management has lifted restrictions to allow some of its funds to buy into companies that make non-banned weapons. 5
Defence companies lift off following Ukraine war, adding to pressure to ease ESG restrictions
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