JumboCash: What is 'socially responsible' investing?

As global temperatures heat up, so has the divestment movement on Tufts’ campus, which demands that Tufts sell its investments in companies involved in extracting fossil fuels. With many socially conscious investors seeking to avoid fossil fuels with their own money, asset managers have begun creating new funds investing in stocks that meet ethical criteria. These funds are called ESG — standing for Environment, Social and Governance — and they have seen a rapid rise in popularity. Before you invest your savings in an ESG fund, it’s worth examining whether these “feel-good” investments truly deliver on their promises.

The typical methodology for ESG funds is to rate companies based on how well they meet environmental, social and governance standards, and then proceed to invest only in companies with high scores. A score for environmental standards might be based on carbon emissions, levels of waste or contributions to deforestation. Social scores relate to working conditions and company diversity, while governance emphasizes history of corruption and bribery. Hence, ESG funds try to create an asset of environmentally friendly, socially-conscious and scandal-free stocks — in theory, at least.

The main issue I see with ESG is the subjectivity of the evaluation process. The criteria can be so broad and contradictory that funds include perplexing holdings. Take Invesco’s ESG fund ESGL, for example, whose second-largest holding is ExxonMobil! A deeper dive into the fund reveals that it owns the tobacco industry titans Altria Group and Philip Morris, alongside defense contractors Boeing and Lockheed Martin. So, even in socially harmful industries, it is possible for a company to score high enough on each pillar to be included in funds.

Even when looking at companies within the same industry, ESG scores don’t always reflect the most environmentally friendly, ethical companies.

A perfect example is the divergence in ratings between Tesla and BMW. In 2018, the ESG rating agency Sustainalytics ranked BMW in the 93rd percentile, while Tesla scored in the meager 38th percentile. This doesn’t make sense: BMW has faced legal trouble related to collusive activity and trying to hide diesel emissions, while Tesla’s entire business model focuses on emission reduction and clean energy usage.

Not only do the holdings of ESG funds appear contradictory, but investors must pay a high price in order to supposedly align their investments with their values. A Bloomberg report on ESG investing found that ESG products cost about 15 times as much as BlackRock’s ETF on the US stock market. 

Just like headphones, shampoo or ice cream, ESG funds are products, and you are a consumer. In this case, financial firms appeal to younger, socially-conscious investors who think they are doing something positive with their money. Consequently, Wall Street charges a higher price for the story they sell, even if the holdings of their funds don’t align with what investors believe they’re buying.

At first glance, ESG investing appears to be a way for investors to align their investing strategies with their core values. However, the subjective nature of screening companies for their environmental impact, workplace culture and governance practices leads to contradictory ratings. There are plenty of ways to have a positive impact with your money, but investing in ESG may not be one of them.