Abstract
Managers seeking to integrate environmental, social and governance (ESG) factors in their investment process face a kind of J-curve in which the majority of the costs are borne up front, and the benefits are not realized, if at all, until well into the future. Yet, the evidence suggests that most investment managers fall well short of full ESG integration. Firms’ performance on ESG factors are approximately normally distributed, with most firms performing somewhere around the mean, and only a few exceptional firms truly using ESG factors to deliver alpha. Which creates a paradox: if the greatest benefits of ESG incorporation are achieved only through the full integration of ESG factors into the investment process, why have so few investment managers adopted the strategy? In this working paper I lay out the case for an ESG integration paradox, and then offer suggestions for asset owners seeking to avoid the worst-of-both-worlds scenario of external managers set up to absorb the costs of ESG integration without the promised benefits.
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