ESG is “a riddle, wrapped in a mystery, inside an enigma.”
-Winston Churchill
Source:- Bloomberg
Climate change. Pollution. Income inequality. Plastics in oceans. What if you invest your money that could solve these global problems while generating above average returns? Well sustainable investing promises to combine the best of both these worlds. Sustainable investing is an emerging discipline which generally means to invest in companies that adhere by the environmental, social and governance principles. And that in short is infamously called ESG investing.
Environmental criteria considers how a company impacts the environment and climate. Social criteria measures a company’s relationship with its employees, customers and investors. And governance deals with the company's corporate structure, management compensation, board of directors, audits etc. Research analysts dive deep into these factors and analyse them thereby assigning a rating. The higher the score the better is its rating.
Source: - MoneyLion
ESG investing means taking into consideration how a company's environmental, social and governance performance will affect a company's financial performance and in turn, use that to determine investing in the company. According to a Morningstar Direct report, a record $45.6 billion went into the global sustainable fund universe in the first quarter of 2020. Interest in sustainable investing jumped to 85 percent in 2019, up from 71 percent in 2015. Bank of America predicts the money in ESG investing could rise to between 15 and 20 trillion dollars because of changing demographics. With these impressive stats there is no doubt that ESG will bring in a new change in the investing trend.
The term ESG has its origins from 2004, where the former UN Secretary Kofi Annan sent out letters to 55 CEOs of the world’s leading financial institutions, inviting them to participate in this initiative that would bridge the gap between investors and important environmental, social and governance issues. The group that formed into what is known today as the Principles for Responsible Investments. More than 2,000 money managers have signed the documents which include the big names like BlackRock, Morgan Stanley and JPMorgan among others.
The one company that has dominated the entire system of ESG ratings is MSCI (Morgan Stanley Capital International) which according to critics is based on unregulated data. The ratings look a lot like credit ratings of a company. MSCI has become the giant in the field.There are about 160 different companies that sell data and ratings that report to rate companies on their environmental, social, and governance practices or factors. MSCI however has a major hand on controlling the ratings.By one estimate, 40 cents on every dollar that is spent on ESG ratings, is owned by MSCI.
Source:- Bloomberg
Sustainable investing can be a very subjective matter and can vary between investors. For example, a person invests in funds or companies that avoid the tobacco, arms and fossil fuels industries. However, for another person, he might be interested in targeting the funds where companies focus on workplace equality, reducing carbon emissions and contributing more to CSR projects. These are just a few ESG strategies. Investors used to think that socially responsible investing would eat into a company's profit and competitive advantage. Now investors see it as an opportunity to identify potential risks or even disasters before they happen.
And well, these may sound all fancy and fabulous things that you are supporting these “good” companies, however behind the scenes it is quite different and many asset managers take advantage of people’s naivety. And that brings on the problem of greenwashing!
So, what’s greenwashing? Well let’s just say they pretend to really care about ESG but in reality, it is the money that they are really interested in. It is just a marketing ploy that is used by the companies. The minute you see a ESG banner on the fund, you believe in it and invest that hard earned money in the so called “good companies”. The moment these funds get to their hands, it is used in a completely opposite way. Because they really don’t bother to look into the nitty gritty of the companies like whether they buy from organic farms or using solar energy etc. According to a recent survey, 44% of the investors are concerned that the ESG investment landscape is replete with issues of greenwashing. For example, the Volkswagen’s emission scandal. This scandal kept its shares in red as the company duped the people into believing that they were buying a green vehicle that was not green. This led to a fine and settlement of up to 20 billion dollars, leading to one of the costliest corporate scandals in history.
Another problem with ESG is that it is very idiosyncratic and that leads to a lot of confusion. Elon Musk recently tweeted, “ESG is a scam. It has been weaponized by phony social justice warriors.” Since Tesla has been kicked out of the S&P ESG Index, let’s just say Musk has been livid. Now you may be thinking, an “electric” car company that shows all sorts of green signs is booted out by the index provider? 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. This may come as a shocker for many that the company that is supposed to drive the world towards sustainable energy is missing in an ESG index. And that’s completely justifiable.
ITC which stands for Indian Tobacco company, is the largest cigarette maker in India. At first you must be thinking that adding this company in the ESG category doesn’t make any sense. And let’s just say that you are right in a way as these companies do 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 seeing the things ITC has done right, you may want to rethink that decision. 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 (Morgan Stanley Capital International) even granted it an 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.
So, in a way ESG is not entirely a scam. It totally depends on how a person sees to it. As it is rightly said, there are two sides to a coin. Regulators have to find a way and have to go after the mutual funds and advisors, who claim that they’ve paid attention to ESG but in ground reality they haven’t. Regulators will also have to work and figure out a standardised way in which all of us can invest and know that our money is being put to good use. Until next time, Happy Investing!
Article by: - J Shree Nidhi
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