For financial professionals only
ESG (Environmental, Social Governance) funds are taking the investment world by storm – there are now more than 2,500 sustainable funds available to investors1, and to date 2020 has seen record inflows. This means fund managers are increasingly embedding environmental, social and governance considerations into portfolios. But there’s no definitive agreement on which E, S and G issues are relevant, how to rank their relative importance, or how to measure companies against them. A recent study2 also found inconsistencies among ESG ratings, with each of the main providers assigning different classifications to the same companies.
E is for environment
Tech companies have relatively good “E” credentials (low carbon emissions) and this has driven many ESG funds to have sizeable allocations to the sector, but not without some “S” concerns. Big tech is disrupting traditional industries like manufacturing and retail, but employs relatively few people,3 which contributes to unemployment, harming individuals and communities. In addition, some big tech firms have come under fire for their tax policy, treatment of workers, lack of affordable housing for lower paid staff, and customer data privacy breaches. There are examples of positive social initiatives though: Microsoft has pledged $750m to tackle the affordable housing crisis in Seattle and Alphabet issued a $5.75bn sustainable bond in August 2020 – the largest ever corporate issue – to support projects related to the circular economy, affordable housing, racial equality and small businesses. But it isn’t straightforward to weigh up the positives and negatives for these large and complex firms.
S is for Social
ESG funds will look to invest in companies with positive social practices such as businesses providing education and healthcare, and those with strong health and safety records. However, this can be difficult to measure because the social benefits are often qualitative in nature and will depend on the specific company. Companies doing well on S could also falter on E. For example, Shell has been recognised as a leading employer4, but it remains one of the largest global carbon-emitting companies from its fossil fuel activities (although it is taking steps to transition to renewables).
G is for Governance
Some of the hallmarks of strong corporate governance include board diversity, fair executive remuneration policy, and good disclosure and transparency. A well-known company that divides opinion here is Tesla. As the leading global manufacturer of electric vehicles, Tesla is making driving more sustainable (although recognising there are E issues, arising from the mining of cobalt and nickel for the batteries). However, there are governance challenges, too. Things have certainly improved since 2018 when Elon Musk was forced to step down as chair of the board to focus on being the company CEO, but his astronomical $55bn bonus package is concerning to many investors.
Alphabet soup
Companies in the real world face many complex issues across E, S and G. For active and passive ESG investors alike, it’s important to understand the approach adopted by the fund manager for analysing and weighing up E, S and G considerations. It can be seen from the divergence in ratings between the main ESG rating providers that this is subjective, and there’s no accepted “right” answer. This can lead to quite different portfolio holdings, with meaningfully different risk and return characteristics.
References
[1] MorningStar.co.uk 2020. How Asset Managers are Embracing ESG [online] Available at: https://www.morningstar.co.uk/uk/news/204075/how-asset-managers-are-embracing-esg.aspx [Accessed 21 October 2020].
[2] Mitsloan.mit.edu 2020. Aggregate Confusion [online] Available at: https://mitsloan.mit.edu/sustainability/aggregateconfusion [Accessed 21 October 2020].
[3] Bloomberg.com 2020. ESG Investing Is Having a Good Crisis. It’s Also Killing Jobs [online] Available at: https://www.bloomberg.com/opinion/articles/2020-05-21/esg-investing-s-good-coronavirus-crisis-is-killing-jobs [Accessed 21 October 2020].
[4] TheTimes.co.uk 2020. The Times Top 50 Employers for Women [online] Available at: https://appointments.thetimes.co.uk/article/times-top-50-employers-for-women/ [Accessed 21 October 2020].
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