There’s a lot of confusion in the marketplace regarding ESG (Environmental, Social, Governance) and Sustainable, sometimes known as SRI (Sustainable, Responsible, and Impact) investing. Many people think the two terms are interchangeable – I’m here to tell you that they aren’t.
Blackrock BLK , Vanguard, and other big investment houses are simply capitalizing on the growing interest in values-aligned investing. In fact, they have invested a significant amount of money in marketing ESG to have you believe that they are the same. Environment, social, and governance metrics are data points that hypothetically deliver insight into how responsible a company is. The problem is that there is no standard by which companies are judged – and the metrics are constantly changing.
A recent Bloomberg article questions MSCI’s MSCI ESG ratings, which is where large firms like those mentioned above get their data. The article says, “…the ratings don’t measure a company’s impact on the Earth and society. In fact, they gauge the opposite: the potential impact of the world on the company and its shareholders.” A far cry from what many investors believe they are getting – positive solutions to make the world a better place.
And herein lies the core difference between an ESG portfolio and a truly sustainable portfolio – a positive, inclusive bias. ESG is about making portfolios “less bad.” A sustainable portfolio is about intentionally including companies that are making a positive difference in the world.
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For example, an ESG portfolio that reduces its exposure to ExxonMobil XOM is “less bad.” A portfolio that eliminates the company entirely is better. But a portfolio that adds First Solar FSLR in ExxonMobil’s place is positive and sustainable.
Blackrock continues to push their extremely popular ESG product, the “iShares ESG Aware” fund. But when I look under the hood, I found holdings such as ExxonMobil, Facebook (Meta), McDonald’s, JP Morgan, DuPont, Hormel Foods HRL , and Caesar’s Entertainment. The only alternative energy stock I could find was Tesla TSLA . While it might be “less bad” than a generic index fund, it certainly isn’t as values-aligned as the name might suggest.
ESG metrics are important, but you cannot passively rely on them to create a positive end result portfolio. To do so, you must ask the question, “Is this company sustainable and does it belong in this portfolio?” Secondarily, a good, active manager will also ask, “what kinds of companies do we want to own and which ones will be leading us into a new, cleaner, and more sustainable economy?” I would posit that the list of companies in the Blackrock ETF above would not pass either of these questions.
According to Morningstar, there are currently 502 different mutual funds and ETFs available in the US that are designated as ESG/Sustainable. I have found that very few actually offer positive, solutions-based holdings. The vast majority are just “less bad” versions of the S&P 500 or some other arbitrary index. It takes a significant amount of rigor and due diligence to identify and sort through the greenwashing to find a fund that truly meets the SRI investment designation.
I often say you can’t invest in the future by looking in the rearview mirror, and that’s what we are doing by basing ESG index funds on traditional indexes. We need to move beyond the current paradigm into one of intentionality where we are investing in the true changemakers and leaving the dinosaurs of the past where they belong – in the past.