Op-Ed: A Wake-Up Call For ESG

In an industry full of acronyms, ESG — the consideration of Environmental, Social, and Governance factors as part of the investment analysis process — is now nearly universally recognized. What was once a concept to which many corporations and fund managers simply paid lip service has become increasingly important over the past decade, as ESG proponents have helped to boost these factors’ importance in the asset management world.

Current data makes clear that ESG considerations do factor into many corporate and institutional investors’ investment decisions. Roughly two thirds of banks screen their loan portfolios for ESG risks, while 90% of insurers and 71% of fixed income investors monitor ESG factors. ETFs and mutual funds linked to ESG-focused indexes have swelled to billions of dollars.

And even outside of publicly-traded companies, ESG has also made headway into the alts universe. Industry professionals attending the latest ADISA or IPA conference can participate in popular ESG sessions with plenty of aedifying education and discussion.

And of course, ESG factors into public policy and politics. Consider the recently proposed reform legislation for the Opportunity Zones program, which includes reporting requirements that broadly comport with an ESG perspective.

So it is clear that ESG has traction, and is likely to be a permanent fixture of the asset management universe for the foreseeable future.

ESG was initially promoted as a way for investors to “do well by doing good.” In theory, companies that prioritize strong governance should avoid certain catastrophic risks (think Enron) while those that prioritize sustainability should develop strong brands and loyal customers (think Whole Foods). ESG also promised to bring increased transparency to markets, a trend many asset managers welcome.

Yet, for all the transparency promised by ESG proponents, the entire concept risks being undermined by industry professionals who appear to be placing their ideological agenda above any semblance of objectivity.

To be clear, this was always a risk. While ESG in theory can be objective and rules-based, ESG in reality always incorporates a moral and ideological belief structure. This is evidenced by the proliferation of ESG indexes and products; there are dozens of methodologies under the ESG umbrella, many of which are seemingly at odds with one another. And the moral and ideological beliefs inherent in these products likely makes any specific ESG framework attractive to certain subsets of investors — and unappealing to others.

One would hardly expect the Gates Foundation to invest in Global X’s S&P 500 Catholic Values ETF, whose tracked index excludes companies involved in abortifacient production. Similarly, one would not expect the Safari Club International Foundation to invest in the iShares ESG Aware MSCI USA ETF, which specifically excludes civilian weapons companies. In the ESG world, moral differences like these must be identified — the devil is in the details.

Nevertheless, in the past several years, ESG has broadly risen to near the top of the agenda for investors of varied religious, moral, and ideological views.

But new events may make it difficult to ignore the extent to which ESG has become more art than science, subject to the ideologies of its architects. Most notably, S&P Dow Jones Indices recently removed Tesla Inc. (TSLA) from its ESG index.

Astute observers have noticed that the removal comes at a time when Tesla’s chief executive, Elon Musk, has increasingly been at odds with the Biden Administration. Mr. Musk has also publicly argued with prominent progressives about various economic and social issues on the Twitter social media platform.

Mr. Musk himself had a blunt reaction to Tesla’s removal from S&P’s ESG index. “Exxon is rated top ten best in world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list! …ESG is a scam. It has been weaponized by phony social justice warriors,” he tweeted.

For its part, S&P justified the removal in a blog post, citing a variety of contributing factors. These factors included “a media and stakeholder analysis”, which “identified two separate events centered around claims of racial discrimination and poor working conditions at Tesla’s Fremont factory.”

But Tesla’s removal from S&P’s ESG index has attracted criticism from industry professionals who question whether S&P may have been motivated by an ideological bias — the type of bias which has caused many political progressives to paint Mr. Musk as a corporate bogeyman.

After all, “sustainability” ranks at or near the top for nearly any ESG index. If the world’s most successful electric vehicle company doesn’t qualify as ESG-friendly, what company can?

S&P staff would no doubt claim that the rigor of their methodology speaks for itself, and that the timing of Tesla’s removal was a matter of happenstance.

Yet, optics matter. Institutions like S&P Global would do well to ensure that they have religious, ideological, and moral diversity on their staff. To do otherwise would risk institutional damage and brand equity that they’ve established over decades.

Or worse, the term “ESG” could become so loaded with ideological baggage that a subset of investors, advisors, and asset managers will simply tune it out.

Hopefully, the current political firestorm can be a wake-up call to industry professionals, because using ESG as a weapon to score short-term ideological points could be the concept’s undoing in the long run.