10 March 2022 |

ESG: Everything (sadly) goes


One of the hotter topics of conversation in finance and climate circles of late has been ESG. ESG has never been perfect; as long as people have tried to construct frameworks to guide more intentional and value-based investing around Environmental, Social, and Governance parameters, there have been disagreements on how that should work.

Since Russia invaded Ukraine however, there’s been a wave of reckoning. Basically no one agrees on what ESG investments should look like. And investors and fund managers alike continue to have problems understanding what they actually own in their diversified portfolios.

Last month, many investors woke up to the reality that their portfolios contained significantly more exposure to Russia than they probably expected. One ESG fund had more than $8B invested in Russian equities, including state owned oil & gas companies like Gazprom. Not sure exactly which of the ‘E’, ‘S’, or ‘G’ parameters satisfied those investments.

The fact that most of these companies’ stock prices got cut in half as financial sanctions hammered Russia’s economy made it harder to avoid questions of how they ended up in ESG portfolios to begin with.

Digging Deeper

I recently spoke with the CEO of a direct investment platform that allows investors to easily create portfolios that track indices but subtract certain companies or sectors, e.g. an S&P 500 portfolio excluding oil & gas companies. When asked for his take on the challenge with ESG, he noted that countless funds and firms all claim to have a better approach for ESG. Which means you end up with countless different standards.

Elon chimes in

And we can see it happening in real time: a Reuters piece from last week quoted one Citi bank analyst as saying:

We believe defence (sic) is likely to be increasingly seen as a necessity that facilitates ESG as an enterprise, as well as maintaining peace, stability and other social goods…

This is the type of goalpost shifting that lands a weapons manufacturer in your ESG portfolio.

My take

Trillions of dollars are already invested based on ESG criteria. And there’s a lot of potential to drive impact by investing that much money. For instance, divestment from oil and gas companies doesn’t necessarily directly affect their bottom line right away. But it can do three things (at least):

  1. Raise their cost of capital in debt markets 
  2. Depress stock prices, which impacts their ability raise money via primary sales 
  3. Signals to senior management that they need to consider running the company differently or lose out on stock and stock option based bonuses

Unfortunately, and to put it bluntly, the past week has made a mockery of ESG. To be clear, I imagine the majority of the sector really does good work in guiding dollars towards more impactful,or at least net neutral, investments. But the headlines prevail, even if there are only issues with 5-10% of how investments are managed.

What I’ll be looking for in the rest of this year is:

  • Tools and policy changes that help ‘re-bundle’ ESG standards. The more disparate frameworks and standards there are, the harder it is to navigate the space and evaluate its impact. 
  • Tools that make it exceedingly simple for investors to understand how their money is invested and what the impact of that is. More on some companies I have my eye on in this space soon.