ESG or is it all BS?

It’s hard to be an ESG investor if everything’s ESG – writes David Kimberley

Reading through the financial report of one investment trust recently, it was interesting to see that the manager had managed to fit holdings in an arms dealer and a major oil company under the rubric of ‘ESG’.

Amusing though this may, it probably won’t come as a shock to Kepler Trust Intelligence readers. ESG is a peculiar acronym because lots of people talk about it, but no one seems to know what it actually means. And because loose definitions are always open to abuse, it’s hardly a surprise that we regularly see a huge range of companies crammed into ESG strategies.

This may be beneficial for fund managers, who can feel pleased with themselves or just tick off the ‘ESG’ boxes they are required to fill in. For regular investors it is far less useful. If a word can be used to describe anything then it means nothing. The lack of a concrete definition or set of standards by which to assess a fund or company’s ESG credentials means that individuals will be hard pressed to work out how suitable they are as investments, assuming they want to take those credentials into consideration.

To be fair to both companies and fund managers, creating such a standard is also very difficult. In order to quantify anything, you need to identify a set of data points that can be validated in some way. Given how subjective things like good governance or strong environmental credentials are, as well as the plethora of industries that exist in the world, it’s tricky to see what data points you should be looking at and how you could apply them universally. Speaking to a data analyst who has been working on this very conundrum recently, his conclusion was that existing metrics are, at best, “better than nothing” – not exactly convincing stuff…

Compounding definitional problems is the fact that the traits ESG analyses seek to examine often don’t tell you much about how good an investment is. Many of the green energy companies which soared in value during the pandemic would probably hit all the right ESG notes. But they were often deeply unprofitable, with little indication as to when that would change. Amid the fog of ESG debate and utopian predictions about the future, it’s easy to forget that financials remain the bread and butter of any business and your goal as an investor is to make money, not engage in philosophical debates.

Does that mean individual investors should totally discount ESG? No, but until a more widely accepted and understood definition of what it means can be found, investors who are interested in the subject will have to do more of their own homework and have their own idea of what it means to them. Doing so will mean they are better able to evaluate the investments available to them.

And as important as financials are, the different areas of a business that ESG analyses seek to examine shouldn’t be discounted. The fact that so many fund managers emphasise the number of company visits they perform shows the importance of things like governance in determining the likelihood of success when making an investment. So even if ESG factors alone shouldn’t be the deciding factor in whether or not to buy, they should be a deciding factor. You only have to look at a company like Wirecard to see why that’s the case.

_Disclaimer

_{This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.}