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Green Investing: The Reality of ESG

Green investing

Whether you love or hate him – it’s hard to argue against Elon Musk’s criticism of the controversial ESG (Environmental, Social and Governance) framework. In 2023, the tech mogul branded ESG “the devil” while sharing a post about how tobacco companies like Philip Morris outperformed Tesla in the ESG ratings.

While Tesla isn’t squeaky clean, the company has revolutionized the electric vehicle industry. On the flip side, Philip Morris is the top cigarette manufacturer in the US. Tobacco has been linked to cancer, deforestation, carbon emissions, waste, and toxic chemicals – need I say more?

That said – Tesla received a low ESG score of 37, while Philip Morris got a glowing 84 out of 100. But ESG is all about sustainability and ethical issues – right?

This isn’t the first time Tesla has targeted the “eco-friendly” formula.

Their Tesla 2021 Impact Report stated, “ESG reporting does not measure the scope of positive impact on the world. Instead, it focuses on measuring the dollar value of risk/return”. The report also claimed that investors aren’t aware that they’re pumping money into companies that are actually making climate change worse.

But this barely scratches the surface.

Fossil fuel companies like Exxon and Shell surprisingly also scored higher than Tesla. Advocacy group Global Witness slammed the latter for greenwashing and misleading investors by directing only 1.5% of the promised 12% of its annual expenditure to “Renewables and Energy Solutions.”

Read more:

 

Can We Trust the ESG System?

 

On paper, it’s easy to see the appeal of ESG investing. After all, it’s supposed to help investors make money while positively impacting the world.

 

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The ESG system measures how organizations deal with concerns and risks in three key areas: environmental, social, and governance. Companies get a score in each area, helping investors identify which investments have solid ethical and eco-friendly practices.

And sustainable investing is on the rise. The Sustainable Signals report by Morgan Stanley found that 77% of global investors are interested in sustainable investing, with 54% saying they expect to increase their sustainable investments over the next year.

As a keen recycler with a love for second-hand clothes, this is music to my ears. Not only can sustainable investing help our planet, but it also has the potential to generate better risk-adjusted returns in the long term.

 

Where do ESG rankings come from?

Rankings come from rating agencies and data providers, such as MSCI, the Dow Jones Sustainability World Index, Sustainalytics, and S&P. The problem is there isn’t much standardization as they each have their own metrics, sometimes focusing more on the E, S, or G parts.

Even with a mix of metrics, you’d hope these agencies would score fairly (it’s only the planet on the line, no biggie). But as we know – money makes the world go round. And it seems some rankings focus more on the company’s income than impact.

 

In 2022, the New York Times reported that top rating agencies are scoring companies on how much harm ESG factors (like carbon emissions) have on the company’s financial performance rather than their social or environmental responsibility.

Let’s take the famous golden arches. Leading ranking agency MSCI had previously boosted McDonald’s ESG score based on “environmental factors”, despite having mammoth greenhouse gas emissions greater than entire countries. But they didn’t consider this in the scoring. Why? Because it didn’t threaten the company’s bottom line.

This suspicious scoring also managed to catch the attention of the big dogs. The Securities and Exchange Commission published a report mentioning how rating agencies may not be applying ESG factors or properly disclosing the methodology behind their ESG rankings.

 

Does ESG Investing Do More Harm Than Good?

 

PoF banner: ESG scoring

 

Let’s cut to the chase – ESG investing, like any investing, is about reaping those rewards.

Whether ESG investments deliver higher returns is a topic of debate. But beyond making a buck, let’s strip it down to what ESG is really about – the environment, society, and governance.

It’s easy to get lost in all the scoring and shady practices, so here’s a quick breakdown:

  • Environmental: Measures environmental impact through energy, carbon footprint, pollution, materials, and waste management.
  • Social: Covers issues relating to labor, human rights, community relationships, and health and safety practices.
  • Governance: Analyses business ethics, risk management, board diversity, and shareholder rights.

So, do these shiny ESG scores truly represent a company? Or are they simply there to line shareholders’ pockets and mislead investors into thinking their cash is making a positive impact?

In simple terms – it’s a mixed bag.

 

The Columbia University and the London School of Economics compared ESG records of US companies in non-ESG and ESG fund portfolios. They found that ESG portfolio companies had worse compliance across environmental and labor factors.

And as we’ve seen in the case of McDonald’s, an increase in ESG score doesn’t necessarily mean less pollution (though they’ve promised 100% certified, recycled, or renewable packaging materials by 2025). Companies can easily raise their score by putting all their efforts into social or governance but totally neglect the environment.

I did some digging and found four companies that consistently appear on the worst eco-friendly lists, then compared their S&P Global ESG scores to some of the most promising in sustainability.

And there wasn’t a huge difference.

Of course, it’s not all doom and gloom. Many highly-rated companies have pledged their commitment to ethical and environmental values. And those with sustainability awards and certifications almost always have glowing ESG scores – so at least that adds up.

So, how are the big corps doing? It’s no surprise that they churn out a lot of CO2e – but they are taking steps to improve. Microsoft aims to be completely carbon-negative, Google is on track to becoming net-zero, and Apple carbon-neutral – all by 2030.

The world is watching, and it seems they are all fighting for that coveted eco-friendly image.

According to S&P Global, Microsoft currently has an ESG rating of 55 and Apple with 52 – both considered high scores.

And boosting those ESG scores can pay off. A study looked at the results of 2,000 ESG performance analyses and found almost 50% showed a positive link between ESG and financial performance, with only 11% having a negative relationship.

But as we’ve seen, it’s not always so clear cut and it’s worth doing your due diligence before adding an investment to your impact portfolio.

 

How to Spot Greenwashing?

 

The ESG system is flawed. If I had my say, I’d include external factors like the overall impact on the environment and society (that would bring Philip Morris down a few notches).

As it stands, ESG and greenwashing go hand in hand. Companies can use their scores and other claims to exaggerate (or completely fabricate) their green status to rope in investors and boost their public image. Organizations will put a ton of money into eco-friendly marketing without delivering tangible results.

But there are ways to fish out companies guilty of greenwashing.

Start with the basics. Companies with flimsy “award-winning” claims, overuse of eco-friendly buzzwords, and images of mountains and rivers slapped all over their products are usually red flags. Style over substance comes to mind.

Many companies are also selective about what they want to reveal. Coffee giants tell you they’ve released straw-less lids, only for you to learn the new lids contain more plastic than the old lid and straw combined (looking at you, Starbucks). Stay skeptical and research claims that feel a little too good to be true.

And unlike a cup of coffee in the morning, the answer isn’t always right in front of you. Plenty is going on behind the scenes like in the supply chains – which bring materials, labor, and suppliers under the microscope.

You can also check for third-party certifications that (we hope) have no ulterior motive other than their commitment to sustainability. These include the B Corp certification, ISO 14001, and Fair Trade. Finding out if companies are compliant with environmental and legal standards is also a smart step.

 

Bottom Line

 

Let’s bring it back to those ESG ratings. I don’t like to generalize, but there are enough questionable cases for you to think twice before investing.

If you’re committed to forming an impact portfolio, my advice is to go detective mode. Dive into the company’s practices to see if it’s all talk or if they really do support their ESG stamp of approval.

 

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3 thoughts on “Green Investing: The Reality of ESG”

  1. Nice post Lauren – i thought it was interesting and ESG has been overhyped. It’d be great to feel good and invest in good at the same time, but ESG is an example of how many preyed on a secular trend.

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  2. Subscribe to get more great content like this, an awesome spreadsheet, and more!

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