ESG shouldn’t convince anyone anymore

ESG (environmental, social and governance) is the devil. That, at least, is what Elon Musk thinks (or what he tweets he thinks). 

That view might be a little extreme, but he’s right that there is something wrong with both the concept (investing with a view to ESG factors) and its implementation. Fund managers have long said that if you follow the ESG rules, you can’t help but win: You’ll make money and you’ll feel good too. It’s looking like they’re wrong. 

Look at it through the lens of the World Cup. Of the 32 countries playing in this year’s tournament, host nation Qatar ranks 24th in ESG terms, as measured by asset manager M&G plc. It scores badly on politicalrights, civil liberties, the treatment of migrant workers and environmental risks; but it does pretty well on rule of law, poverty and inequality reduction, and social stability. 

Qatar scores a little lower than Argentina (which hosted in 1978) and Brazil (2014) and a little better than Mexico, which is set to host in 2026, along with Canada and the US. Mexico scores horribly on corruption, stability and peace. Anyone minded to be bothered about ESG might then want to steer clear of both this year’s tournament and the next one. 

You will see where I am going here. Shift back to ESG in the context of markets, and it is obvious that from an investor point of view it is extremely difficult to understand. What looks bad in ratings might not be as bad as you think. 

Everyone now knows, for example, that AI. (Artificial intelligence)-driven ESG ratings firm Truvalue Labs gave FTX a higher score on “leadership and governance” than it did Exxon Mobil Corp (although the crypto exchange did get a low overall rating). Say what you like about Exxon, it’s still producing a product we need, it’s solvent (shares are up 84% in the last year), it’s listed, and it has a proper board of directors. FTX cannot say the same. 

There are now so many companies involved in producing ESG ratings, in so many different ways, that it is verging on impossible to nail down anything concrete. M&G used MSCI data for the country ratings I cite above. But there are hundreds of different rating agencies, often telling, as the CFA Institute put it, “vastly different stories” about the same entity. 

The core problem is the attempt to quantitatively measure something essentially subjective. Everyone will have their own ideas about what should — and should not — bring out the armbands. And everyone will have a different method of analysing the endless grey areas. There are so many standards, there may as well be none. 

Perhaps ESG should simply come down to every fund manager looking at company management and asking, “are these honest people?”, as Abrdn plc’s Harry Nimmo suggested to me recently. Fortunately, the UK Financial Conduct Authority (FCA) and other global regulators are thinking about this. There are even plans afoot to introduce new classifications and labels — such as “products have the sustainability characteristics they claim to have” — to effectively shoehorn Nimmo’s question into a spreadsheet. And they are planning regulation for the rating agencies. 

This may help, or it may add more acronyms to an already acronym-crowded space. Either way, Musk’s devil is surely in the detail. 

Yet, there is another problem looming for the ESG industry, rating agencies and fund managers alike. They might be making money as the fees keep rolling in, but their clients are not. 

Investment Metrics notes that some 78% of global ESG equity products under-performed their benchmarks in the first half of 2022 (though 80% outperformed over three-year period). A lot of managers will be wishing they’d been less absolute on fossil fuel and mining companies. It turns out that not only do the products of these firms have positive social value, but that this has been reflected in their share prices. 

Add up the incomprehensibility, inconsistency and the lack of performance, and it should be no surprise that investors are increasingly sceptical about ESG investing, says the Association of Investment Companies. Although 60% say they think about it (down from 65% last year), 58% say they are not convinced by claims from fund managers on the matter (up from 48%). 

At a recent conference, the FCA’s Mark Manning pointed to research showing that 86% of retail investors don’t know who to trust in the fund management market full stop. Perhaps more importantly, however, it isn’t clear that investors really want to be convinced by fund managers about the depth of their goodness. 

Fund flow data from Calastone shows that ESG equities suffered their first outflow in 3.5 years globally in September (albeit that’s within the larger context of outflows from most areas). Numbers compiled by research firm Refinitiv US Holdings Inc. show £9 billion (RM47.47 billion) of outflows from equity ESG funds in the UK. 

Might it be that people prefer a few rounds of greenwashing and virtue signalling to an investment process that excludes large parts of the market? — Bloomberg 

Merryn Somerset Webb is a senior columnist for Bloomberg Opinion covering personal finance and investment. Previously, she was EIC of MoneyWeek and a contributing editor at the Financial Times.

  • This article first appeared in The Malaysian Reserve weekly print edition