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Is ESG A Valuable Investment Metric?
ESG — Environment, Social, Governance, is apparently being used by more investors to assess risk and opportunities. Scores arise to assess how well a given company is addressing these issues. From a pure investment standpoint, the value of this metric is to be proven someday in the future. It is political rhetoric for now.
The questions?
While almost every business recognizes it has responsibilities to society taken as a whole, it must decide how much it can afford to spend managing that obligation and still survive. As with people, multi-tasking tends to reduce the overall output. You get the best results when you focus.
- Is business the best medium to achieve societal results? Would it be better if businesses focused on productivity and innovation and used some of the resources created to fund organizations dedicated to the goals?
- Would two focused organizations provide better results than one trying to provide both?
Maybe the ESG part should be broken into three dedicated organizations.
Where to find the ratings.
Morningstar provides a search tool so you can get a score. Company ESG Ratings. I would you use it carefully. As you should expect, most of the factors considered are fuzzy. The metric relates only to risk. Presumably, opportunity either does not exist or is the complement of risk. The automobile industry is an example of confusion, at least for me and given there are three factor categories, it is possible a company could be very strong in one category and very weak in others.
Volvo (17.0) is a low risk company. Tesla (28.5), Ford (30.0), Mercedes (22.8) and Toyota (28.9) are medium risk. General Motors (30.8) Hyundai (31.0), Nissan (31.7), are each high risk.
At this point, you might wonder how you can use the number rationally. You probably cannot. Go to the SP Global ESG Scores site for insight into relative importance of the 1,000 factors they consider. You can enter a name and get the results in some detail. In these scores high is better. GM is immensely better than Tesla on all metrics. Now where are you?
The questions I have are these.
What risk is Mornigstar talking about?
a) It seems that the only risk is the company will be unable to sell their product at a profit because it pollutes the environment either in use or production, it treats its workers badly or it is poorly managed. None look terrible on those metrics.
b) Alternatively is it a way for the activists to pick a business that doesn’t meet their particular daily standard for adherence to the preferred narrative?
Are there funds or ETF who have used ESG as a selection tool?
My answers so far
The alternate b) answer to Q1 is contemptible and merely demonstrates the shallow vision of the propagandists. The a) part has some meaning, but there are very few businesses that have the worry.
As it turns out, there is information about Q2. The Wall Street Journal had a piece on the subject in the 10 July 2022 issue. Andy Kessler’s headline writer named it, The Many Reasons ESG Is a Loser. The subtitle tells the story, ” You’ll pay far higher expenses for a fund with similar stocks but worse performance.”
Hardly a recomendation
The article referred to Balckrock ETFs and how there fees wrere 5x higher than an SP500 index ETF. 15 basis points versus 3. Blackrock seems to have found a way to create an opportunity.
I am willing to reconsider, but
Can anyone demonstrate how a company scoring a high ESG score is a better investment than one with an ordinary score? I can see the value on the governance metric and maybe on the environmental metric. The social metric eludes me. It has always been my belief that competence outweighs any other factor. For example, I recently had a conversation with an exceptional high school teacher. The consensus was, you cannot pay a good teacher too much andf you cannot pay a bad teacher too little. The problem is salary relates to years expereince, which is a weakly connected metric, and education, which need have no connection whatever to teaching.
I wonder if anyone knows if good teachers leave early and weak teachers generally stay. It is not so different in business. In economics Gresham’s Law says, “Bad money drives out good money.” and in my experience the same rule applies to workers. Businesses grow stronger by focussing on strengths not on weaknesses.
Has anyone created an anti-ESG fund? It would be interesting to see if it is really that much riskier.
The bits to take away
The ESG metric is based on subjectively decided indicators and scores. Possibly well thought out bu still subjective.
The ESG metric seems to be a metric that is beyond a point, is unrelated to sound business practices. In my experience, no business sets out to harm workers, customers, or the environment. Good governance is in their best interest and so is simplicity.
Businesses that try to maganage too many goals eventually solve none of them optimally.My cycnic self says the ESG Rating is a cudgel not a valid business metric.
Decide what you want to accomplish with your investments and the decide how much you would give up of that to achieve someone else’s idea of a better world?
I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.
Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.
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