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ESG Investing: Does It Distort the Market?

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If you thought ESG investing was a slowly emerging trend in capital markets, think again. The Environment, Social, & Governance imperative for companies, new-fangled "ratings agencies," and the money managers who must decide whether or not to buy the stocks is now a very big part of the market and a giant business unto itself.

According to the Nasdaq exchange, ESG-integrated strategies assets under management (AUM) were $8.2 trillion as of the end of 2020, up 34% from the end of 2018. More on Nasdaq research coming up.

$30 trillion. That was the amount of assets cited in late 2019 by Linda-Eling Lee, then Global Head of ESG Investing for MSCI, that now "fall under the broader umbrella of sustainable investments." This is probably globally and the Nasdaq figures were domestic US and possibly a stricter criteria.

Do Good By Investing Well?

At the time in December 2019, there were over 160 ETFs based on MSCI ESG indexes. Had I been paying closer attention then, I would have seen that this may not be a passing fad.

In an interview with Investor's Business Daily, Lee referenced that giant $30-T amount as coming from the Global Sustainable Investment Alliance. Based on that research and MSCI projections, she said "The millennial generation could be putting between $15 and $20 trillion dollars into U.S.-domiciled ESG investments."

I assume she meant in their investing lifetimes. It's still staggering to think that the total AUM in ESG are approaching $40 trillion in this decade. Or even much faster, since a 2020 review by the Global Sustainable Investment Alliance showed that the "industry" just breached $35 trillion, "a growth of 15% in two years, and in total equating to 36% of all professionally managed assets across regions covered in this report."

$35 trillion and 36% of global assets? The world must certainly be on the fast-track to sustainability if all this money is pouring into companies doing good on the triple bottom-line of profits, people, and planet, right?


When I first heard it, I was confused. Last August, the Financial Times published a story titled "Funds branded ‘ESG’ are laden with technology stocks." And not just any tech stocks. The big ones.

Here was the lede from author Camilla Hodgson...

Investment funds branded as “sustainable” are under fire for their heavy exposures to US tech giants at the centre of controversies over data privacy, labour practices and monopolistic behaviour.

When I checked for myself on some of the top holdings of your vanilla ESG index or ETF, I was indeed surprised to see that they basically matched the top 5-7 names in the Nasdaq 100 weighting: Apple, Amazon (AMZN - Free Report) , and Microsoft.

In many, even Tesla (TSLA - Free Report) makes the top-ten holdings, like the iShares ESG Aware MSCI USA ETF (ESGU - Free Report) which has Tesla as the 7th largest allocation right behind Alphabet.

Which gets me asking "Does Tesla get such high ESG marks for EV production and energy carbon credits that their environmental impact with lithium mining is overshadowed?" I already give Elon Musk top billing as the man who single-handedly forced the auto and oil industries to get cleaner...

The F-150 Lightning Will Crush the Tesla Cybertruck

But the main point of Hodgson's article is about socially responsible investing watchdogs asking questions like: How are these ESG index decisions being made such that Facebook slips through the criteria screen despite numerous data privacy and disinformation issues?

Is it that big tech gets such a great rating for their carbon footprint that they get a pass on social and governance issues? We can also wonder what the energy impact is of massive data-centers consuming hundreds of terawatt hours (TWh) of electricity, including extraordinary cooling requirements.

We know this will only grow as data is the new gold to collect and store and process. The server farms of FANGMAN know no limits at present.

In the video that accompanies this article, I look at research from various sources to uncover the mysteries of ESG being dominated by FANG-type behemoths. A very good report came from Refinitiv in September titled Sustainable investing and FAAMG stocks.

There is so much good info that report, I may have gotten carried away in the video talking about ESG growing to $70 trillion in AUM. Here was the actual paragraph I was trying to reference...

As such many investors are now seeing if their investment manager is a signatory of Principles for Responsible Investing (PRI), the world’s leading proponent of responsible investing. It currently has 1,750 members, representing about US$70 trillion of investments.

What this means is that asset managers who represent that much money have signed on to PRI, not that they've put all their money into ESG indexes. Still the force of the trend is clear, even if the incentives are not.

Externalities, Incentives, and Feedback Loops

All this got me thinking about how the game is currently working. Who benefits from creating and then following an ESG index? Clearly MSCI has found a new source of business in being the data, research, and consulting resource for such a big new industry. In the video, I also highlight how the Nasdaq electronic stock exchange has emerged as a player in the ESG consultancy business, advising companies, money managers, and regulators.

The exchange has a paid article on CNBC to promote a new report that emphasizes the urgency of companies reporting ESG metrics. “The right time to start ESG reporting was yesterday” says Meagan Tenety, Senior Lead ESG Advisor at Nasdaq, who lead the report. “Today, if you don’t already have something in place either from a regulatory or shareholder’s perspective, you are at risk of being left behind.”

We should welcome their expertise in advising companies who will have no control over either the regulatory moves of governments nor the ESG reporting metrics that get handed down to them. The field of measuring "externalities" is still a young one and, while necessary, it may have some growing pains along the way that are as susceptible to distortion as any regulation that runs the lobbying gauntlet on Capitol Hill.

Right now, as I begin my understanding of the ESG investing movement, I'm just making new observations this week about how big this "industry" has become and where the incentives and feedback loops exist.

For instance, one might be curious about how investment managers decide to put money in an ESG ETF. Is it purely a branding move to improve public image? If so, it doesn't hurt at all since it's just another legitimate way to gain FANGMAN exposure. And what about the companies who must be weighed and measured by ESG... do they have incentives to rearrange the furniture to create certain grades?

Regardless of the perceived pressures for the investors and the companies, the reality has been a double-play scoring drive in giant tech stocks since the pandemic accelerated digital transformations, at a pace of something like 10 years in just 10 months.

Active ESG Offers Alternatives

There are many other hidden incentives within capital markets that exploring ESG investing might reveal. But it doesn't mean the industry and its metrics are ones to resist or ignore.

In hunting for clues, I found a good new article from Forbes Advisor by editors Rob Berger and Benjamin Curry titled The Best ESG Funds For Great Returns & Low Costs. They explain the two big options for investors are either passive (linked to an index as we've discussed above) or active ESG mutual funds and ETFs that conduct their own research to identify funds that meet their criteria.

But within these big categories are dozens of great options to tailor a "do good" investment philosophy.

Forbes Advisor combed through about 80 fund options to identify seven of the best ESG funds that they believe are worthy of your consideration. I chose to look at the holdings of theiShares Global Clean Energy ETF (ICLN - Free Report) . It's linked to an index, but it consists of 30 companies from around the world involved in “clean energy-related businesses, comprising a diversified mix of clean energy production and clean energy equipment and technology companies.”

And, of course, no FANGMAN here. Just pure, concentrated clean energy technology. Which concentration also has its unique risks. But the strength of this report from Forbes is that they picked eight investment vehicles (mix of ETFs and mutual funds, passive and active) and they put them all through the same methodology where they look at risk factors like this.

Plus, Berger and Curry give a good summary of ESG definitions that I show in my video.

Bottom line on ESG: Overall, it must be a force for good to measure company externalities and hold investors accountable in some way. It just seems we got into a weird phase of its evolution with the concentration in mega-cap tech stocks. I look forward to reading about the movement at the end of this decade and if created the changes we wanted, or more unintended consequences.

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