Calling out ESG

Impact in brief • 3 min read

Calling out ESG

Reversing the idea of sustainable investing.

Once shunned as being too restrictive and hindering returns, ESG (Environmental, Social and Governance) investing has exploded over the last eight years with $425B invested in ESG funds in 2021.

But now a report by Bloomberg Businessweek has shown one of the leading ESG ratings companies “flips the very notion of sustainable investing on its head” by not even “measuring a company’s impact on the Earth and society”.

Investors are increasingly questioning the sustainability credentials of funds and in many cases going as far as accusing them of greenwashing, a term used to describe the false branding of something as sustainable.

MSCI global ESG index

The spotlight has recently focused on MSCI, the largest global provider of financial analysis indices and ESG rating systems. Analysis of MSCI’s indices by Bloomberg found that they consider 90% of the US S&P 500 index of companies to be ESG compliant. Put another way, only 10% of companies are considered to pose any kind of environmental or social risk.

Take a closer look at the MSCI Global ESG Index and you will find companies such as BP, ExxonMobil and Chevron, some of the largest oil companies in the world and not what you would expect to find in a sustainable index.

This goes a long way in explaining how some ESG indices managed to significantly outperform others during 2021, which was an unusually poor year for sustainable investors.

Morningstar cutting the list of funds

MSCI is not alone. Morningstar, another of the large index providers recently hit headlines as it cut the list of funds that it recognises as sustainable by 27%. 1,600 funds that it had previously considered as sustainable were reclassified.

The move was triggered by European regulators who are becoming increasingly hot on what is and isn’t considered to be sustainable.

So why is this happening?

The intention of ESG analysis is to assess the exposure of a company to environmental, social or governance risks, not to measure the positive impact it is having on the world as many people have come to think.

ESG risk can be very subjective with many different interpretations which is where the problem lies.

For example, some ESG methodologies might assign a high ESG rating to BP because, relative to competitors like Shell, it has a few stricter policies in place rather than because it is intrinsically a sustainable company.

Companies have built up entire teams focused on improving their ESG scores but they usually focus on the messaging rather than making any kind of operational improvements. They are essentially finding ways to play the system.

Is any ESG analysis reliable?

Not all sustainable investment approaches should be tarnished with the same brush and there are many companies out there executing sustainable strategies effectively. Often a truly sustainable strategy uses ESG as a foundation to build upon because, as we have just discussed, ESG is a murky world.

If all sustainability minded investors relied solely on ESG we would get nowhere in creating positive change in the world. Understanding your fund provider’s interpretation of ESG and sustainability is critical.

How CIRCA5000 is different

For CIRCA5000, ESG screening is only the first step of many.

It is about screening out companies that have a materially negative impact on the world, not about seeing which company is doing a slightly better job than the rest.

We think of ESG as a first line of defence to try to ensure no companies with a negative impact on the world make it into our themes. Once we have validated the implementation of the ESG screening and verified the output we can focus on our main pursuit: investing in companies that are positively impacting the environment and society.

Capital at risk.