June 7, 2022
Previously published on Forbes.com
It was a bad May for greenwashing. On the 31st, German police raided Deutsche Bank and its asset management group DWS over accusations that they fudged their Environmental, Social and Governance (ESG) credentials. On May 25, the SEC proposed new rules that would require ESG funds to disclose their goals, criteria and strategies along with data measuring ESG progress. Two days earlier, the SEC fined BNY Mellon $1.5 million for “…Misstatements and Omissions Concerning ESG Considerations.”
Last but not least, on May 18 S&P Global kicked Tesla off its new ESG index and, adding insanity to injury, swapped in Exxon Mobil. The climate activist who smeared cake on the Mona Lisa’s bulletproof casing seems quite reasonable by comparison.
Of course, Elon Musk tweeted in response to S&P Global’s decision: “ESG is a scam. It has been weaponized by phony social justice warriors.” While I empathize with Elon (not always easy to do…), I think his diagnosis of the problem is too simplistic.
While the intention of ESG investing is good and should be applauded, investors are right to wonder: is ESG a scam? Unfortunately, the answer is often yes. From Blackrock whistleblower Tariq Fancy to finance professor Sanjai Bhagat, critics have been making that case for years (as have I).
However, I don’t think “social justice warriors” have commandeered ESG funds, as Musk suggests. Rather, fund managers know a marketing opportunity when they see one. They have lured socially conscious people into thinking that their investments can save planet Earth from a climate disaster—if they just pay inflated management fees.
Trying to find an analogy for this state of ESG, I came up with this. In Italy, I once visited a kosher butcher who displayed awards and prizes around his shop. Asking the butcher about them, I found out that he bought those prizes—because they encourage customers to buy his goods. No one thought to ask whether they were real. He called them “decorations.”
Now, imagine if that butcher decided to sell “award-winning” kosher ham.
Correct, that is impossible. Meat can be ham, meat can be kosher, but kosher ham is a contradiction. Likewise, a fund could be ESG, a fund could have Exxon Mobil in its portfolio, but an ESG fund with Exxon Mobil is kosher ham. Or halal ham. Or dry liquid. Or an elderly baby. I think you get the point.
The SEC is right to protect investors and demand that ESG funds substantiate that label if they’re going to profit from it. The question is, what really qualifies a stock for inclusion in an ESG fund?
Intuitively, we (ought to) know that Tesla is doing more to reduce carbon emissions than Exxon Mobil, which continues to explore and drill for more oil. But determinations can get complex.
How about the tech companies? As MCSI’s Rumi Mahmood illustrates, companies like Apple, Microsoft, Alphabet and Amazon are prevalent in ESG funds. While they have viable plans to lower emissions—thankfully, data centers can use intermittent energy sources like wind and solar—these companies are not necessarily innovating technologies that can reduce emissions at a civilizational scale. They are ESG-friendly insofar as they are not detrimental to the E in ESG.
What about lithium, nickel or copper mining companies? Their operations produce significant emissions—and often have social and governance problems—yet their products can power a Tesla.
How about a company that produces grey hydrogen from natural gas but is investing in wind and solar to produce green hydrogen? Does it deserve a high ESG score now or in five years, when the green hydrogen is actually produced?
From water conservation technology and flood mitigation systems to plant-based meats and lab-grown leather to nuclear fusion and carbon capture, it’s not easy to determine which companies score highest for the E in ESG, and when. At best, most ESG funds invest in the status quo, not in the future of energy, industry and materials.
Neither regulators nor analysts nor the companies themselves have a standard for scoring ESG. In the absence of standards, swindlers are free to profit from the label. The SEC is right to address these abuses, but more must be done.
In my opinion, ESG is a doomed concept without:
In the meantime, it is our responsibility to question the claims made by ESG funds. A mere glance at the portfolio might tell us all we need to know. If you happen to see Exxon Mobil in an “ESG” fund, just remember: kosher ham.