Sustainable Environmental Insights from Vermont Financial Advisor Josh Kruk.
Last month, S&P Dow Jones kicked Tesla out of the ESG version of its S&P 500 index. In addition to making Elon Musk’s head explode, the move added to a growing debate about whether an ESG label has any real meaning for consumers.
As the predominant electric vehicle brand in the world, Tesla’s environmental qualifications are hard to argue. However, S&P’s rationale is built around its view of Tesla’s performance in the social and governance categories. Working conditions at a plant in California and a safety investigation with regard to the company’s autopilot function were among the items cited.
While those concerns are valid, it seems ironic that S&P’s methodology booted Tesla from an ESG index while retaining several large fossil fuel companies. Although the ESG index has somewhat lower fossil fuel exposure overall, it actually holds more of ExxonMobil and Conoco than the normal S&P 500 index. In fact, as of the end of May, ExxonMobil was one of the ten largest holdings in the ESG index!
S&P’s decision spotlights an issue that plagues ESG as a concept and lies at the core of much of the current pushback by critics: complexity.
ESG is naturally subjective in that one person’s view of what is most important may differ from another’s. By extension, the criteria used by indexes and fund providers to screen out companies, and the relative importance assigned to each of those criteria, may vary significantly from one provider to the next. This can lead to markedly different holdings across ESG-branded funds, creating complexity, confusion, and counter-intuitive results.
S&P’s exclusion of an electric vehicle manufacturer and inclusion of a huge fossil fuel company is a case in point. Over-engineered and opaque processes can lead to outcomes that, for many sustainably-focused investors, run counter to simple common sense.
In that context, some of the recent criticism of ESG is understandable. However, the issues seem to be less about the concept and more about the implementation. One of our consistent mantras is the reduction of complexity. Perhaps we’ve reached the point where the term “ESG” has become too complicated and subjective for its own good. Maybe the term is no longer even useful. When we think about what really matters, it’s less about the name of the fund and more about what is actually held inside it.
Ideally, the industry would make the process easier by replacing complicated mechanics with a smaller number of simple screens accompanied by a clear explanation. In the absence of that, investors can reduce subjectivity and complexity by prioritizing a smaller number of issues they care most about and looking for funds whose holdings best match those criteria.