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The S&P 500 ESG Index has kicked out Tesla Inc (TSLA), the company that made electric vehicles cool: That’s the latest nonsense in the world of environmental, social and governance (ESG) investing, which according to Bloomberg Intelligence projections will govern nearly $38 trillion of assets by the end of 2022.
In the real world, a vice to some is frequently a virtue for others. But in a stock market that’s heavily segmented, indexed and ultimately ETF’d, ESG ratings can and do have a major influence over prices, particularly in the near term—though the methodology calculating them is arguably opaque as ever.
Tesla, for example, is the world’s leading manufacturer of EVs, considered essential to decarbonization efforts. Yet investors who buy ETFs based on the premier blue chip “virtue” index will no longer own the stock. Nor will they have shares of NextEra Energy (NEE), the leading US producer of wind and solar energy.
Dow Jones’ ESG index does include, however, leading oil and gas drilling company Baker Hughes Company (BKR), oil and gas producer EOG Resources (EOG) and leading fossil fuels refiner Valero Energy Corp (VLO). And it also deems Caesars Entertainment Inc (CZR) sufficiently virtuous, though that company owes its current prosperity to promoting gambling, which many consider to be a vice.
This week, Dow Jones’ marketing team cited alleged “racial discrimination” and “poor working conditions” as reasons for removing Tesla. In my view, it’s more likely their timing is related to the heightened controversy surrounding the takeover offer from Tesla CEO and 15.73 percent owner Elon Musk for social media giant Twitter Inc (TWTR).
But whatever the case, I’d better dollars for dimes investors who own ETFs based on Dow Jones’ version of ESG principles would find it incredible the company most associated with decarbonizing global transportation is now excluded. Ditto the fact the Index is heavily weighted in several of the world’s largest fossil fuel companies, as well as ironically Twitter.
In the October 21, 2021 Income Insights “S&P Global Clean Energy Index: Making the Case for Picking Your Own Stocks,” I highlighted several questionable features of Dow Jones’ model for renewable energy ETFs that investors aren’t likely to be aware of. Among them: The exclusion of four of the largest renewable energy deployers in the world NextEra Energy, Enel SpA (ENEL, ENLAY), Iberdrola SA (IBE, IBDRY) and RWE AG (RWE, RWEOY).
The apparent rationale from Dow Jones is these companies also operate fossil fuel power plants. Yet the same is true of Clearway Energy (CWEN), which is nonetheless the 26th largest holding of 100 in this index and related ETFs like iShares Global Clean Energy ETF (ICLN).
This ETF also holds shares of majority-owned, consolidated units of Enel and Iberdrola, which somehow merit inclusion while their parents do not. And it owns stakes in biofuels and grey hydrogen companies as well, hardly examples of zero emissions companies.
Certainly, investment companies that sponsor indexes and related ETFs have the right to determine what they hold. But that also means the onus is on investors to find out what’s inside, and whether it matches up with their objectives.
Bottom line: No one should ever assume an index or ETF with “ESG” stamp of approval is invested according to one’s own principles, or equally important holds stocks they want to own.
In Dow Jones’ eyes, for example, the fact that Tesla has a controversial CEO and isn’t a union shop appears to be more important to its relative virtue than the fact that it’s a key driver of global de-carbonization. Conversely, Ford Motor Co (F) has been a leading global manufacturer of gasoline-powered, CO2 emitting vehicles for a century plus.
Yet Bloomberg Intelligence reports the company is now included in 591 ESG-related indexes and 37 actively traded ESG funds. Could that be because increasing the percentage of women in its workforce and on its Board of Directors is considered more important?
Again, virtue is in the eye of the beholder. But equally, neither does anyone have a monopoly on what constitutes a virtuous portfolio, or a one-size-fits-all system to determine one.
Inspire Investing, for example, features the Inspire 100 ESG ETF (BIBL) that owns stocks of major companies management deems to uphold principles of “Biblical Responsibility.” Companies I like as businesses that made the cut include utility and offshore wind developer Avangrid Inc (AGR), life sciences REIT Alexandria Real Estate Equities (ARE), utility Centerpoint Energy (CNP), copper miner Freeport McMoRan Inc (FCX), healthcare REIT HCA Healthcare (HCA), leading gold producer Newmont Mining (NEM), industrial REIT Prologis Inc (PLD) and energy services giant Schlumberger NV (SLB).
Some of these companies including Alexandria REIT overlap with Dow Jones S&P 500 ESG Index. And as noted above, Avangrid Inc (AGR) is a member of Dow Jones’ S&P Clean Energy Index.
Caesar’s, however, most definitely would not pass Inspire’s definition of virtue, which eschews companies in the business of gambling and selling alcohol. And while even the most liberal ESG investor would likely applaud management’s close attention to human rights violations, they would probably find objectionable the group’s avoidance of LGBTQ activism.
The lesson here isn’t to give up entirely on investing with your beliefs. But doing that well will be a lot easier picking your own stocks than relying on, for example, an index machine like Dow Jones or an ETF marketing colossus like Blackrock or Vanguard.
Your investment returns from making your own choices will almost certainly be better as well. The S&P Clean Energy Index, for example, is down roughly -11 percent year to date and -42 percent since peaking in January 2021. The S&P 500 ESG Index is lower by -18 percent this year, roughly the same return as the broader S&P 500.
In addition, the Clean Energy Index ETF yields just 13 basis points while the ESG Index pays only 1.65 percent. That’s less than half what an investment in Avangrid would pay.