ESG is tricky to talk about thanks to the politization of it. I work on some projects that involve ESG data and I have some thoughts. First there's LOTS of factors. If you bunch them all up into one number, it becomes meaningless as the article describes. I would think wiser minds would use this data to make investment decisions based on some specific risk, like hedging against some environmental disaster which may affect some companies more than others. Also, one thing I notice is that umbrella companies make ESG data complicated. Sometimes there will be data from a subsidiary but not the parent, how that all bubbles up is of note. Companies may use this to manipulate their scores. And quality of the data is important, it is based on research not any sort of testing or analytic model, so one must trust the researchers in this case (or not).
"When a measure becomes a target, it ceases to be a good measure"
Any ESG system that uses a calculated number composed of many areas will quickly fall prey to Goodhart's Law. With an E, an S and a G to work on, the areas for change are numerous enough that Goodhart's Law holds even in a non-cynical world.
When an edict that "We need to increase our X score this quarter" is handed down, the real, living people who have to improve the ESG rating are likely limited in what they can do. A combination of pre-existing contracts and commitments, difficulty in changing large systems and problems with multi-department co-ordination means that most changes will be small and isolated, i.e. things where one department or small team can implement the entire change.
I'm working adjacent to the sustainability space, and I think Goodhart's law applies to a good degree, however a bad measure is often still more useful than no measure at all. It at least enables us to show flaws, develop better indicators and metrics.
When it comes to human rights in the supply chain and environmental impact, there was a complete lack of data in many cases. With the ESG, we see a major shift where companies are now scrambling to gather said data, analyse it and often also publish it.
Partially the politicization of it, but also because it is lumping together three issues that the society cannot even broadly agree one of the issues within 'ESG'. I don't think it is difficult to see why "ESG" is political by its nature.
Thanks this is a nice way of saying what the other poster said :)
I agree, ESG is just a bunch of numbers but if we can't agree on what the right output is then it's political in nature. I wonder if society has a bigger issue with disagreements about the E and S rather than the G, maybe not?
"Society" has plenty of disagreements on the G, but, fortunately for the companies in question, shareholders don't. G measures, essentially, how much the company prioritizes its shareholders.
I think there is a strong case for that, companies concern themselves with governance constantly and I would agree that there is less to be concerned about there. It seems like governance problems have been pretty well worked out over time and there is a good process for that even before the focus on ESG.
E and S are where many draw their political divides so I would tend to agree that is where many of the problems lie within ESG.
That's most of investing though. Investors won't all agree the operating cash flow, asset base, organic sales growth if there's been M&A, etc. let alone with a P/E, P/FCF, EV/EBITDA ratio makes a company cheap or expensive. Yet, this doesn't make it political in nature though.
As you note, the politicization of it makes it difficult to point out the flaws without people assuming you like hate the environment or something. The problem is, like any score, it's easily gamed. That's how we get companies like ExxonMobil having great ESG scores.
The Atlantic had a great article about it:
"When you invest in an ESG fund, you may think you’re buying into a highly curated selection of positive-outlier companies. In reality, it will often look similar to an ordinary market-wide index fund. The 10 biggest holdings in the S&P 500 ESG index include Big Tech companies such as Apple, Microsoft, and Alphabet; big banks such as JPMorgan Chase; and, incredibly, ExxonMobil."
ESG is a way for large firms to manipulate the stock prices of smaller firms and buy them out. That is all there is to it. Nobody should be fooled by this. None of these companies care about ESG or any of the propgandized ethics of ESG. Every one of these pro-ESG companies would lay off a large swath of their workforce if it meant higher profits. Pretty painful for the "S" social part of ESG.
Making an assumption that the factors into an ESG score are significant in how they affect a company; isn't investing into a company with a bad ESG sub-component(s) a good idea?
You've identified what is going wrong with the company so as a large fund you can buy a lot of shares and push for shareholder votes to fix those aspects of the company and reap profits when the company improves?
> isn't investing into a company with a bad ESG sub-component(s) a good idea?
Yes, that is the paradox of the ESG finance trend.
Using a quantitative approach, you can use the CAPM to show that at equal risk/return, increasing the cost of capital of some companies (by limiting their access to funding because of low ESG score) actually make these companies a comparatively more profitable investment (for those that disregard ESG).
If you like these kind of paradoxes based on investor ethics, have fun discovering the world of Islamic finance and how to get interests when you cannot get interests.
