Plenty of people have hurt their feelings as Tesla was kicked out from S&P500 ESG index this week. Simultaneously some oil companies were added to the index. How come the company that made e-vehicles so popular can be dealt like this? Well, not going to write a book about this, but explaining this briefly. It's typical ESG ratings (indices use esg ratings as an input) try to analyse two dimensions. Firstly, what company produces (is the output a problem or a solution) and secondly, how does the company operate and how the output is produced, and what sort of risks and opportunities these two issues generate for investors. When it comes to ESG indices, in this particular case the index aims to have the same sector weights as the parent index ie S&P500. Also, there are some categorical exclusions like arms (remember this is not a homogenous group, some produce legal weapons whereas some others produce weapons that are banned in international treaties), oil sands and companies that are not aligned with UNGC etc. Thereafter, the index only accepts companies whose esg rating is not among the worst in each sector. Tesla, it is easy to see the output is beneficial for the environment. Hence positive contribution for ESG rating. However, how the output is produced or how the company operates seem not to be top notch and this more or less cancels 'the good' from the first dimension. Oil companies have to be in the index according to the methodology (equal sector weights compared to parent index). As we know there is supply shock going on in the energy sector, therefore short term positive market value development. As the market in general has been in downward spiral, sector's weight has increased nicely, therefore more companies from that sector in S&P500 ESG index. Which oil companies? Obviously those that have good ESG ratings WITHIN energy sector. Should be pretty clear? Of course one can argue why there are oil companies in the ESG index. There is plenty of different esg indices, some have oil companies whereas some don't. Reading the methodology always helps to understand how the index is constructed and tells what sort of companies can or cannot be included. Same applies to esg ratings. Methodology helps to understand things a lot. Sorry this became a bit longer than I initially thought What do you think? #Tesla #ESG #sijoittaminen #ilmastonmuutos #climatechange #investing
Good points! I think the main challenge is simply about communications and misunderstandings. Asset managers need to be clearer what the funds and indexes are about and what they are not about. The "index composition first and scoring second" approach is probably not understood by many, i.e. that it has to "force" a certain balanced composition across sectors rather than just selecting the absolutely highest-scoring companies from the market portfolio. Then, when oil prices hike, you see more oil&gas companies in the index, creating understandable frustration. Also, people tend to mix e.g. climate and ESG. Many people probably have "climate" in mind when investing in "ESG", because climate is more concrete thing to understand and also dominates the discussion. Asset managers need to be clearer with these things in their marketing. Maybe the typical factsheet language is not perfectly understandable among retail customers. I somehow believe that many people misunderstand these indexes as sector / theme funds, i.e. funds investing "in the solutions" such as clean energy. What's your view, you have much better visibility on this?
ESG has problems, and those who lobby against it, whether from the fossil energy industry or those who believe in a libertarian world, find themselves empowered, and sense they are shooting fish in a barrel. Yet it's not only these groups. Many from developing nations are latching on to the backlash, saying that 'it's alright for rich nations to preach ESG but what about us, our mineral extraction opportunities, or our ability to build an industrial base. The birth of the € could be used as an analogy for the situation in ESG at this time. The € was cobbled together as a political ambition before the economic ducks were lined up. I am pro-EU but agreed with the choice to keep the £. I want a common currency, but one based on economic rather than political considerations . I agree with the ambitions of ESG. The extremes don't, left or right. Unlike the Euro, ESG lacks political will, the private sector has been left with a significant chunk of the responsibility of implementation/deployment. Political support for the E part is there, but hedgy. The S has created a strange coalition of oil lobbies and campaigners for rights in the developing world. Taking Musk into account, the G has simply disappeared.
This whole debate presumes that an investor is actually making an impact by tracking the S&P 500 ESG Index to begin with. It is a laughable untruth.
Esa Nurkka
1y
Mika, thank you very much for the education regarding ESG methodologies. I've learned a lot from reading these discussions. The whole idea of ESG still puzzles me. The big goal of sustainability is naturally the right one, but the idea of being able to offset a poor E-rating with ambitious S & G (or vice versa) sounds flawed to me. It's kind of like beating your kids on Friday, and compensating that with double doses of icecream and candies on Saturday. And then we have Tesla. I admit to being a blatant fanboy of Elon Musk's ENGINEERING achievements in Tesla and Space X. However, the whole Twitter acquisition case has been annoying. A few hours ago Musk tweeted that Tesla is building a hardcore litigation department, reporting directly to Mr. Musk, which I find even more worrying. Seems that Elon Musk wants to write his own laws. Conclusion: While Tesla is doing incredibly valuable and sustainable job saving the planet, it's CEO and main owner (while being a genius engineer and entrepreneur) can also be an arrogant jerk. What is the price of saving the planet? If Tesla is totally maximizing it's efforts on Environment, and setting the bar lower ("just obeying the law") on S & G, would that be a fair deal?
Well stated Mika, totally agree! Your most important point is, "read the methodology", many don't do that... While I could write a book about this, I'll settle with trying to underscore that few things are binary, particularly so "ESG" as a general concept. On the other hand, if an end non-professional investor should understand the financial products they invest in, alot of communication, education, simplification is likely needed, and European regulators are certainly moving forward here... We simply have a long way to go, and I guess my go to response in most cases when people complain about ESG ratings and inconsistencies or perceived irrational outcomes is to compare an ESG rating to an equity valuation paired with ethical values, mega trend assumptions and much more. Therein lies no specific truth, but information, and even a simple equity valuation sometimes tell you that quality companies, like any other company, can be overvalued from time to time. Have a good weekend Mika!
The fact that two separate risk areas like E & S are lumped together in one aggregated category doesn't make things easier. A company that is performing well on E doesn't have to perform well on S, and vice-versa. I have always found it interesting why E and S are combined in ESG? We do not talk about TC-ratings (tax and cyber risk), and the reason is that it would not make sense to view these separate areas of risk in aggregation. I currently only work with Diversity&Inclusion/Human Capital data and ratings, and even in this specialized area of S - the granularity in data and models are key. Two companies can perform equally good on aggregated D&I, but one might be bad on the Gender dimension, but excellent on the Race/Ethnicity dimension while another is the opposite. Not to then forget the other dimensions like disability, age, education, sexuality, family, etc. I am biased, but believe the solution to the current ESG challenges is more granular data. Mika Leskinen - thank you for starting this discussion. Many interesting points in the comments.
Excellent summary Mika. Regarding Tesla it's quite interesting some people doesn't pay attention codes of business conduct along with racism and poor working conditions. Also neglecting to track own emissions decreases the idea and goal of transition to sustainable energy.
Mika Leskinen this seems to be a circular argument, which tautologically explains why this absurdit’s has arisen. What it demonstrates is that the methodology is either deeply flawed or corrupt. Likely both. I had minimal trust in mutual funds ability to allocate capital in an efficient way and long term way, now I have none. Picking individual companies is the way to avoid gross missallocation of capital both at personal and at system level. It’s appears to be core reason why despite a desire to adjust direction, we are accelerating into the iceberg.
No normal consumer understands all of this. So the whole ESG is just marketing garbage. They should better consist to make a point of view about consumer spendings and sustainable acting. Companies won't change, consumer does.
Thanks for this Mika, it's slightly frustrating how nowadays there's so much discussion around ESG, but often the basics have been forgotten or people start criticizing or praising something without first looking into e.g. the methodology behind it. And sure, the publicly available methodologies might be a bit opaque, but they do give the basic info such as whether the analysis is industry-specific, as in this case. In the end, ESG is just metrics and data, it depends on use case and objectives how you want to utilise that information (or the lack of it). Then it's a whole other discussion whether ESG scores should be constructed differently or whether they should be used at all (because other tools and metrics are available as well). But we will never get to that if we get stuck in the binary discussion of ESG is good/bad.