Stuart Kirk, head of HSBC Asset Management’s responsible investing business, compared last May the current concerns about the climate crisis to the Y2K bug doomsday predictions. During a presentation at a conference sponsored by the Financial Times, Kirk posted a slide with the following text: “Unsubstantiated, shrill, partisan, self-serving, apocalyptic warnings are ALWAYS wrong.”

Kirk doubled down on his statement, taking central bankers and politicians to task for attempting to “out-hyperbole the next guy” when talking about environmental, social, and governance investing. That didn’t sit well with his employer. HSBC suspended Kirk shortly after his presentation, and he resigned from the bank in July.

In an opinion piece published earlier this month in the FT, for which he once served as editor of the Lex column, Kirk applauded the recent questioning of what’s driving ESG investing. Kirk wrote that while he is “pro-ESG,” he believes responsible investing has an “existential defect.” Once that defect is corrected, “ESG can thrive.”

ESG investing’s flaw is one it was born with. On one hand, fund managers, analysts, and rating agencies have understood ESG investing to take into account environmental, social, and governance issues when trying to evaluate potential risk-adjusted returns on an asset.

On the other hand, investors wanting to put their money into “ethical” or “green” or “sustainable” assets want to do the right thing. The right thing usually includes not burning coal, promoting diversity, and requiring transparency.

For Kirk, the first approach to ESG investing considers the three factors as inputs to investment decisions. The second approach considers those factors as goals (outputs) that should be maximized. While not mutually exclusive, the two approaches often clash.

It is acceptable to own a polluting stock in a manufacturing company that has terrible management, Kirk says, “if these risks are considered less material than other drivers of returns.” That is especially true if the risks are already discounted in the share price. Good luck convincing an investor who wants to maximize environmental, social, or governance goals that often don’t have a short-term payback. The eventual payback on ESG goals may take decades, and it may not even result in a financial reward.

As for greenwashing, Kirk says there is none in an “ESG-input context because sustainability is not the point.” If a fund manager is not walking the fund’s talk, that’s “just a process issue” that can be corrected.

The dueling factors in ESG investing make fund reporting “nonsense,” according to Kirk. Comparing a fund’s ESG score to an index is “meaningless” if ESG is just one input. For example, if the market sours on stocks with low ESG ratings, fund managers are probably going to want to be buying if the price is low enough.

For investors with a goal-oriented (output) view of ESG investing, Kirk notes that virtually all portfolios are measured against input indexes like those from MSCI, Sustainalytics, or proxy shareholder services like ISS. He questions if clients understand that the funds are being measured against incompatible indices.

The solution, Kirk writes, is to cut ESG into two pieces. Input funds would be designated as such, and investors looking for long-term ESG goals could avoid them. As for the output funds, Kirk says the industry needs to be “honest about the trade-off between returns and ‘doing good.'” Index providers — and by extension, proxy advisors — cannot rate “goodness.”

The Corporate Citizenship Project, a corporate governance think-tank, ventured a slightly different proposal in the same vein.

“Instead of calling a fund an ‘ESG fund’, why don’t fund managers define specifically the types of companies they will and won’t invest in and why or why not? From there, investors can make their own decisions on whether a fund’s values and potential trade-offs in returns merit consideration,” said Bryan Junus, Chief Analyst for The Corporate Citizenship Project.

What they can do, of course, is lead ESG investors to believe that goodness is, in fact, a fund’s goal, is attainable, and is something worth paying higher fees for.

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