Companies are increasingly bending over backwards to let us know how ‘good’ they are, often with the aim of luring investors and attracting higher valuations.

The idea of bringing about meaningful change through the choices we make as investors and peering beyond simple concepts of maximising profits and minimising risks, is appealing to those that believe getting bang for your investment buck and creating a better world need not be mutually exclusive.

But where for a time investors flung themselves into funds focused on environmental, social, and corporate governance (ESG) factors, the challenging plight of the global economy and financial markets has seen many flee the scene, pulling cash out of ESG-focused exchange-traded funds (ETFs) faster than you can say ‘climate change’.

Bloomberg data in March 2023 showed the iShares Aware MSCI USA ETF – the biggest ESG ETF in the US – had lost nearly one-third of its assets in outflows in 2022, stripping just over $6 billion from its books.

This volatility cuts to the chase of a larger problem; that ESG continues to struggle to find a comfortable and definable home in the world of investing.

LACKING AN IDENTITY

A major issue with ESG is that it lacks a clear definition, which makes it difficult to regulate properly. This means it can too easily be used as marketing spiel, or ‘green washing’ as it is often called, rather than driving the returns-based change that it is designed to do.

Even identifying ESG ETFs and funds, and measuring relative performance is not straightforward. ‘There isn’t an easy way of doing this,’ say Ryan Hughes, AJ Bell’s head of investment partnerships. Morningstar, he says, which provides much of the data for AJ Bell’s platform, ‘hasn’t put a flag on all funds considered to be ESG unfortunately’.

ETF data website www.justetf.com, a valuable resource for retail investors, says there are a broad range of indices and ETFs available for sustainable investment. However, it also warns that these products can ‘differ significantly in their general approach, which means that not all indices are equally well suited to you and your personal and ethical objectives’.

Sustainable, responsible, ethical, impact, clean green investing  – these are all terms that regularly get knocked about when we think about the concept of worthwhile investment under the wider socially responsible investing (SRI) and/or ESG umbrellas.

GREEN WASHING RACKET

That means it only takes a touch of creativity for funds to include (or exclude) any companies they like. And with an estimated 200-plus different providers of ESG scores, the same company – Apple (AAPL:NASDAQ), say – can rank well with one provider and poorly with another, or positively on one issue, negatively on another.

Staying with Apple, the world’s most valuable company has ‘made substantial progress in its ESG efforts,’ according to London-based Permutable Technologies, a consultancy which is trying to provide stakeholders with the tools needed to accurately assess corporate ESG credentials, particularly around climate change.

Apple, Permutable accepts, has faced criticisms, including tax avoidance, exploiting workers in factories in China, environmental impacts, and board diversity. On the other hand, the iPhone maker has committed to reducing waste, enhancing energy efficiency, investing in renewable energy, and implementing innovative initiatives like the Smart City Initiative and air quality improvement programmes.

Overall, while Apple does not score that well on governance and social metrics, according to Permutable’s data, it ranks among the consultancy’s most ‘environmental companies,’ according to its website. And here is where the confusion sets in, because so too does Chevron (CVX:NYSE).

In fact, add up all the scores, including the UN Sustainability Goals achievements, and divide by the total (317) to get a percentage, Chevron ranks as the better ESG investment, 60.2% versus 49.8%.

ANGER MANAGEMENT

Presumably, this is because of Chevron’s work in LNG (liquified natural gas), biofuels, carbon capture schemes and wider decarbonisation projects, but for an oil major to score 77% on environmental factors will leave many investors cold, others angry.

This is not to have a pop at Permutable, but this example illustrates why assessing corporate ESG metrics is complex and often leaves investors completely befuddled, with little faith that ESG scores actually measure if a company is having a positive impact with any accuracy.

In an industry (investment) where growth and profitability are under constant pressure, many asset managers have been accused of ‘green washing’ in the hope of grabbing a piece of the ESG investment growth pie.

If investors really want to make a positive returns-based impact, let alone reach the United Nation’s 17 Sustainable Development Goals by 2030, it will require more and higher quality data and measurement.

FRUSTRATION WITH ‘GOOD’ INVESTING

Given this backcloth, is it any wonder that many investors are becoming jaded by ESG, even those that fundamentally support the principles. Authors from a recently published academic study revealed that sustainable investing was more likely seen as a fair-weather option, with investor demand for socially responsible investing varying a lot based on income shocks and economic stress.

That should not really come as a surprise. When the stock market bears start growling most investors are likely to triage their investment objectives more savagely than during bull markets, and ‘touchy-feely’ ESG investments may fall by the wayside. And as disposable incomes shrink, investors are increasingly likely to turn the risk taps off, prioritising safer stocks and funds which, with luck, have a greater certainty of generating cash and returns through the economic winter.

In other words, while ESG investing is important to many investors, qualifying companies and funds need to be evaluated on the same earnings viability and strategic thinking just like any other investment.

Investors collectively have a huge opportunity to reshape capital markets for the better. By demanding higher standards, they can help force both the ETF providers and the companies they invest in to improve their transparency, accountability, and their impact on the world around us. But we are not there yet.

Disclaimer: Financial services company AJ Bell referenced in the article owns Shares magazine. The author of the article (Steven Frazer) and the editor of the article (Tom Sieber) own shares in AJ Bell.

‹ Previous2023-06-08Next ›