ESG investing may be good investing but it isn’t simple

There is evidence that ESG investing isn’t only good for your morals; it is good for your portfolio, but it is complex.

ESG stands for environmental, social and governance. You could say that ESG investing is investing morally, with your conscience. I keep hearing that these days, it is profitable too.

Yet when you drill down, the best hard evidence I can find about the profitability of ESG investing is that you won’t do any worse by applying this approach. According to a report from the IMF, ESG investing doesn’t mean lower returns.

But the report did warn, however, that “ESG-related disclosure remains fragmented and sparse, partly due to associated costs, the often voluntary nature of disclosure, and lack of standardization.”

And maybe that is all an investor needs to know — you can invest ethically, appease your morals and be no worse off than someone who sets ethical issues aside.

Yet instinctively that doesn’t feel right. We keep hearing that investing is a long-term game. But isn’t that the point about being an ethical business? Caring about staff, your carbon footprint and how your products are used is good business in the long term.

Maybe the problem with reports looking at the profitability of ESG investing is that the benefits are in the future and so reports looking at historical returns miss the upside.

Climate change is real, sooner or later applying sustainable business practices will be compulsory, a matter of law. And the companies that can get this approach right in advance of this will be better able to cope when being sustainable becomes a matter of business survival.

Or take another example, use of data. There is a growing body of evidence that companies that apply high standards in respecting their customer’s privacy see a financial boost from this approach.
To take a high-profile example, Apple sees its approach to privacy as one of its unique selling points.

But it is complicated

But as ever when you drill down, things get messy. Take Apple, it may like to talk about its approach to privacy, but there is no shortage of critics.

Some services can provide an ESG score. For example, if you go to Sustainanalytics, you can type in the name of a company and get its ESG risk rating.

But then I notice, Tesla has a very high ESG risk rating — higher for example than the ESG risk rating for Daimler, Honda or Toyota. And yet, I would say no company in the world is doing more to help combat climate change. Critics say its lithium-ion battery manufacturing damages the environment, but they overlook that this is an evolving process. The end game is to have a super clean method of making batteries, but at first, there will be issues. Tesla isn’t particularly celebrated for worker’s rights either. On the other hand, look at the scale of its ambition and what that means for fighting climate change.

I wonder whether ESG ratings should also award extra points for the scale of the positive benefit. Indeed, I note that different ESG indexes rate Tesla differently. As this piece in the FT   states: Tesla “is rated in the bottom 10 per cent of all companies by one rating agency (JUST Capital) but receives an ‘A’ grade from another (MSCI).”

Ethics of technology

There are all kind of ethical issues associated with technology — not just privacy and data, but considerations such as evidence that AI can be biased, or echo chambers, for example. These are incredibly important ethical considerations, but we are at the very early stages in understanding them.

What can investors do?

One route for investors is to invest in ESG funds — and The Share Centre has already covered some of the options available here.
But above all, do your research. Check the ESG score, but remember, the issue of ethics is nuanced.

Article originally published on share.com