ESG funds, or those that bill themselves as taking environmental, social and governance factors into consideration when making investing decisions, have seen record inflows this year, prompting some, including SEC commissioner Hester Peirce, to call for greater oversight.
The primary issue, and where the SEC comes in, is whether funds that say they are investing based on certain principles are actually following through. But that's where things gets tricky since many of the so-called ESG factors, like brand appeal for example, are subjective and therefore impossible to uniformly judge or quantify.
"The first issue is that we don't even know what ESG means," Peirce said Tuesday on CNBC's "Squawk on the Street." "The notion that we can come together and we can get our regulator to focus on an amorphous set of qualities other than the long-term financial value of a corporation, I think we're fooling ourselves."
A record $17.76 billion has flowed into sustainable-focused ETF and open-end funds this year through the end of November, according to data from Morningstar, more than tripling last year's $5.5 billion. The surge comes as investors demand greater transparency from companies, and as the Street increasingly views ESG risks — such as high employee turnover rates — as material threats to a company's long-term future.
But as momentum builds behind ESG investing, so too do calls for greater clarity over what exactly a fund means when it says it has an ESG mandate. Some investors say that fossil fuel companies, for example, have no place in socially conscious funds, while others argue that since companies are going to be producing oil no matter what, investors should reward the best actors in the space.
Peirce, appointed to the SEC in January of 2018, is one of five commissioners including chairman Clayton. She has been a known and vocal critic of ESG investing. "Not only is it difficult to define what should be included in ESG, but, once you do, it is difficult to figure out how to measure success or failure," she said in a June speech.
It is the labels, rather than the principle-based investing strategy to which Peirce objects. She argues that these labels are not needed since companies have been taking factors like governance into consideration for decades. More importantly, she believes that companies should exclusively focus on their long-term financial value, since when corporations are doing well and the economy is booming, people begin to care more about issues like the environment.
"Having corporations accountable to one group, and that is shareholders, is a really valuable way to make sure they are doing the most that they can do for society. I don't think trying to give corporations and their managers multiple targets to multiple audiences to please is really a very wise idea," she said.
These comments come as the SEC is reportedly investigating a number of firms offering ESG-related investment strategies, according to The Wall Street Journal.
"It's a way for people to signal that they're trendy, and they're investing in a way that's consistent with those trends. But it also enables them to have a fair amount of discretion about what they're doing when they're investing using that label, so that's my concern," she said.