In today's Finshots we see all the problems plaguing the ESG universe

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The Story

The ESG name is being sullied.

Last week, the US Securities and Exchange Commission (SEC) revealed that it was investigating Goldman Sachs for lying about its ESG credentials — specifically related to some of its mutual funds. A month ago, the SEC fined BNY Mellon for fraudulently stating that all investments in their funds had undergone an ESG quality review. And a couple of weeks ago, over in Germany, authorities launched a raid on the asset management arm of Deutsche Bank and accused the firm of lying about their ESG practices as well.

So, what’s going on?

Well, let’s take it from the top.

ESG stands for Environment, social and governance standards for screening investment opportunities. Environmental criteria consider how a company impacts the environment and climate. Social criteria measure a company’s relationship with its employees and customers. And Governance deals with the company’s corporate structure, management compensation, audits etc.

Typically you have a bunch of research outfits that dive deep into these factors, analyze them and assign a rating. The rating then conveys to people if the company is doing well — on the environment, social and governance criteria. The higher the score, the better the company’s ratings.

And since most people care about making the world a better place, there’s a lot of money flowing into funds that score well on the ESG front. From barely $1 trillion in global ESG funds in 2019, the figure has nearly tripled to $3 trillion today. That’s a quantum leap in a very niche form of investing.

And while it might seem like a fabulous thing to support these “good” companies, many asset managers seem to be taking advantage of people’s naivety. We’re talking about the problem of greenwashing!

What’s that, you ask?

Simply put, asset managers pretend that they really care about ESG just to get their hands on your money. They know that everybody’s interested in the ESG game. So they tag their fund with the “ESG” banner and create slick marketing material that’ll convince you to fork out your hard-earned money. And while you naively believe that they’ll be using your money to invest in “good companies”, they go out there and do the exact opposite because they can’t really be bothered about figuring out the nitty-gritty — like whether a company is actually buying goods from an organic farm. Or whether it is recycling its water and switching to solar energy. The marketing presentation is just a charade. A front for them to raise money and collect high fees.

And regulators are worried that many asset managers are not playing by the book. According to one survey, 44% of investors are concerned that the ESG investment landscape is replete with issues of greenwashing. And regulators are just trying to get asset managers to turn more honest.

But there’s another problem with ESG as well. And that problem lies in how subjective it can be, thus leading to confusion.

Just ask Elon Musk who’d tweeted last month, “ESG is a scam. It has been weaponized by phony social justice warriors.” Tesla had just been booted out of index provider S&P’s ESG index and Musk was livid. That’s right, an “electric” car company that’s supposed to be all sorts of green was shown the door, while the emissions spewing oil company like Exxon Mobil was rewarded.

And that means, if you were to buy a mutual fund in the US with the ESG tag attached to it, there’s a good chance that you won’t find Tesla in the portfolio. You’ll find an oil company instead. The reason is simple — Tesla scored quite poorly when it came to laying out its carbon plans, and there were allegations of racial discrimination and poor working conditions too.

But isn’t it still quite a shocker to find a company that is supposed to drive the future of sustainable energy missing in an ESG index?

Such confusion is also quite rampant in India which has seen a slew of mutual funds companies jumping on the ESG bandwagon and launching their own funds in the past couple of years. For instance, take ITC, India’s largest cigarette maker. At first glance, you’d think, “cigarette companies have no place in any sensible ESG portfolio.” And in a way, you’d be right — they pollute the air and destroy our forests. So it’s no wonder that ESG-focused mutual funds in India have given ITC the cold shoulder. But if you look at things that ITC does right, well, you might have to rethink your choice. ITC has been carbon positive for 15 years, water positive for 18 years and solid waste recycling positive for 13 years. That’s a lot of boxes it’s checking. And rating agency MSCI even granted it a AA rating on the ESG scale placing it head and shoulders above many other Indian companies. So judging by just the ESG scale alone, you’d have to pick ITC over many others.

To borrow Winston Churchill’s words, ESG is “a riddle, wrapped in a mystery, inside an enigma.”

So yeah, while ESG isn’t actually a scam, regulators will have their work cut out for them as the ESG brigade gathers momentum. They’ll have to go after mutual funds and advisors who “claim” they’ve paid attention to ESG when they actually haven’t. And they’ll also have to figure out a standardised way in which all of us can invest and sleep soundly at night knowing that our money is actually being put to good use. Till then, the doubts will keep creeping in.

Until next time…

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