Environmental, social and governance (ESG) initiatives may not be delivering meaningful change due to poor quality engagement, according to a paper from PGIM, which warned that 'engagement washing' is “poised to be the next term maligning” ESG initiatives.

The paper pointed out that institutional investors already engage with companies they invest in to improve ESG practices, but questioned whether “engagement activities really deliver impactful, positive, real-world outcomes”?

PGIM also said that there is “genuine bewilderment” that engagement between investors and firms “is not living up to the expectations of its proponents”, in turn creating an emerging “engagement expectation gap” around ESG.

“When it comes to mitigating the negative impacts of certain economic activities on our environment and society, engagement can be influential, but it is rarely transformational,” the paper stated.

In light of these concerns, PGIM urged investors and companies to “cut through the rhetoric to bring clarity to the true role of engagement”, arguing that by focusing engagement on “outcomes directly linked” to investment strategies and performance objectives “investors are more likely to influence positive change”.

PGIM also advised focusing on goals that are “attainable for companies and resonate with management”, as well as targeting areas where investors can support firms to improve.

“Searching for positive alignment between engagement goals and investment outcomes will ensure that the former are within the boundaries of economic or technological feasibility and are both attainable and value-enhancing for companies,” said PGIM, the asset management business of Prudential Financial.

It also said that engagement on ESG should also look at its positive impact on valuations, credit ratings and the desirability of the firm among investors.

Authenticity

“When it comes to engagement, quality and authenticity should be prioritised over quantity,” stated PGIM’s report.

“By focusing on target investment outcomes – financial, sustainability, or both – engagement reporting can reflect how the way companies respond to engagement paves a path to achieving investment objectives.

“Asset managers also have a responsibility to share their experience and views with policymakers to highlight the limits of seeking to achieve real-world outcomes through financial markets.”

This article originally appeared on our sister title, Better Society.

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