By Daron Pearce, founder and CEO of Daron Pearce Associates

Last year I thought about buying an electric car. That’s what was worrying me before the pandemic.

However, events over the past 18 months have created a sense of urgency forcing individuals and companies to dramatically rethink their priorities including how investments shape their relationship to the environment, society and governance.

As a result, 2020 saw more than $47 billion swept into ESG stocks.

In March 2021, Vanguard decided to join the Net Zero Assets Managers Initiative (NZAM). ESG investing is of course all about commitment to mitigating the negative impact of business on the environment and society by positioning for change. So this feels like a pivotal moment. But is it really?

Tariq Fancy, former chief investment officer of Sustainable Investment at Blackrock, describes what he saw in his time in ESG investing: "This multi-trillion dollar arena of socially conscious investing is being presented as something it’s not. In essence, Wall Street is greenwashing the economic system and, in the process, creating a deadly distraction."

Michael Martin, a private client manager with Seven Investment Management (7IM) sees the momentum as coming, not from the global investment firms, but from their clients: "In conversations over the past 18 months with families and individuals I advise, green investing has become a big priority for them, either because they wish to invest in a future-proof way, or because their children have asked probing questions about where their money is invested — and millennial and Gen Z children are keener than ever not to inherit what they think of as "dirty money"."

So, if this desire for change does exist, where should we start? To navigate the most difficult challenges, we should focus on our present failures in order that we can create a different future. Action on these will power a new direction and bring greater clarity to ESG investing, which is why I have chosen them as 2022's key trends to watch:

• Transparency in ESG data and reporting
• Social resilience and the impact of Covid-19
• Threats to nature and biodiversity
• The net zero pledge and its implications
• How governments are going green
• Greenwashing in ESG bonds

What follows is a more detailed look at the ways that investment firms and their clients can positively support the shift to ESG, especially in the aftermath of the Covid-19 crisis.

1. Getting the most from ESG data

 ESG ratings may seem impressive, but ESG ratings are often fiction.

CSRHub's research is one of a long line that shows that the correlation between the ESG score from different rating agencies can be as low as 0.3. And disagreement between rating agencies is just the start of the problem:

• Size biases can work to the advantage of larger firms.
• Sector benchmarks can make seriously unsustainable companies look like high scorers (think of oil and gas).
• Scores are usually static even though trends are constantly changing.
• Collecting and comparing data is difficult because there are no regulated standards.

The future of investing is in ESG, but the inconsistency in ratings has a real impact on the confidence of investors. In Aggregate Confusion: The Divergence of ESG Ratings, MIT researchers highlight the three major consequences of inconsistent ESG scores:

“First, ESG performance is less likely to be reflected in corporate stock and bond prices, as investors face a challenge when trying to identify outperformers and laggards...Second, the divergence hampers the ambition of companies to improve their ESG performance, because they receive mixed signals from rating agencies about which actions are expected and will be valued by the market. Third, the divergence of ratings poses a challenge for empirical research, as using one rater versus another may alter a study’s results and conclusions.”

So, what can you do to address ratings inaccuracies? The answer: healthy scepticism accompanied by activities that challenge the status quo:

• Evolve your investor-investee relationship into a partnership where you actively compare and help to improve the ESG performance of portfolio companies.
• Drop the "black box" metrics and unpack ESG scores using in-house analysis to defend your investment decisions.
• Automate ratings analysis to reduce the dependency on inaccurate or poor quality ESG data and improve trust.
• Watch out for sustainable finance policies that will cause a (painful) revolution as companies are forced to put their deeper data on assets out there.
• Don't depend on past performance to determine future challenges and prepare for a shift to forecasting future ESG risk.

Each of these steps will help you to make sure that you don't put yourself in a disadvantageous position when investing in ESG. Even if some ESG data is deeply flawed, there are still ways to make ethical and financially sound decisions.

 The second part of this Opinions article will be published on Thursday 28 October.