The Problem with ESG

In this video, I will explain the problems with ESG and why it is one of the greatest threats to the financial world in a long time. WATCH NOW

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Sources:

The Street – https://www.thestreet.com/etffocus/blog/sp-500-esg-index-tesla-out-exxonmobil-in

Bloomberg – https://www.bloomberg.com/news/articles/2022-08-24/blackrock-ubs-among-firms-named-energy-boycotters-by-texas

https://www.bloomberg.com/company/press/esg-may-surpass-41-trillion-assets-in-2022-but-not-without-challenges-finds-bloomberg-intelligence/

Exxon Mobile spills

https://www.statista.com/statistics/531336/number-of-oil-chemical-and-drilling-fluid-spilled-by-exxon-mobil/

Dec 23, 2021 Exxon Mobil facility in Texas

Mar 26, 2022 Exxon Mobil facility in Montana

Wells Fargo Report

https://www08.wellsfargomedia.com/assets/pdf/about/corporate-responsibility/environmental-social-governance-report.pdf

VIDEO SUMMARY

ESG stands for Environmental, Social and Governance. Companies rated as ESG investments are supposed to be doing things that are good for the environment and social causes. The idea of ESG was started by the United Nations in the 2000s, as a way to highlight industries that were doing good in the world. The idea was that a company’s financial statements alone sometimes do not tell you the whole story.

Imagine two companies. These companies have roughly the same financial performance. They are about the same size with the same amount of profit every year. Their financial statements look the same. But when you look at the companies in real life, they might act quite different. One might regularly do good things, whereas the other one might have a reputation for bad actions, whether it is being damaging to the environment or a range of social issues. The idea is that over time, investments in the good company will outperform investments in the bad company. ESG is an attempt to separate out the good companies from the bad companies to help you make investment decisions. It is a metric in addition to the financial statements to provide you more information as an investor.

Whenever you talk about ESG, there is a couple of ideas that everyone gets confused about. So, I want to be clear about a few points.

  • Environmental themed investing is a good thing. Investment funds that have a certain theme have been around a long time. You may not want to invest in an environmental company, but it is good that you have the option.
  • Investors should consider factors outside of the financial statement. How a company acts ethically may not be captured in the financials, but can impact your investments.
  • More disclosure from companies is a good thing. Part of this discussion is about companies having to disclose to investors their environmental impact as part of their financial statements. As an investor, anytime you can get your hands on more information, it is a good thing.
  • Certifications are a good thing. One good example of this is LEED certification. Everyone knows what LEED is when you talk about a LEED certified building. There are different levels that correspond to how environmentally friendly a building is. Certifications provide useful information.

Most people agree with these things, and they think that is what ESG is. I am here to tell you that…

  • ESG is different from all of these things. It is not a certification. It is not providing investors more information, and it is not even necessarily better for the environment. A lot of investors do not realize what they are investing in.

ESG is meant to be a “best-in-class” metric, meaning that it is impossible for everyone to become ESG. It is not like a certification, where if you meet all the criteria, you get a stamp of approval. ESG means that someone is deciding which companies get to be labeled as best-in-class, and you are either “in the club” or “out of the club.”

Here is how it works. You have a number of ESG ratings agencies who determine who gets the ESG label. They gather a bunch of information on these companies, either through direct surveys or through the news. Ratings agencies look at a number of criteria, like whether companies are polluting, do they have diversity on their company board, or do they have a history of corruption.

The investment banks then create ESG investment funds based on the ratings. As an investor, you can invest in an ESG fund that is supposed to be best-in-class. Why wouldn’t you want to invest in the best-in-class? These funds have become enormously successful as a sales pitch for investment banks. Specifically, for government pension funds. For example, the State of California has 260,000 employees who pay into some form of retirement program. If you are the person managing the pension funds for California, it looks good to be able to say, I am investing in ESG funds. This has led to massive growth for the banks. As of 2020, there is more than $35T in these ESG funds. This money only goes to the few companies who are on the ESG list.

The problem is that ESG is not a certification, there is no set standards, and a lot of discretion on who gets the label and who does not. A lot of times, the decisions on who gets the ESG label are being decided based on political views. If your company supports the government’s response to the pandemic or the “Green New Deal” you have a better chance of getting the rating. One example of this is Wells Fargo ESG Report from July 2021. In this report, Wells Fargo makes the case that they should get the ESG label, because of their participation in an advertising campaign pushing COVID-19 vaccines on black communities. There are many more examples like this, where pushing a political agenda is affecting their stock price. Of course, there is a wide range of opinions on these issues. The result is that ESG is creating two separate capital markets. The companies labeled “best-in-class” are getting more access to capital. If you do not get the ESG label, your company is getting cut off from capital.

This creates one of the greatest threats to finance in a long time. ESG is sucking money into a small group of companies based on a non-financial metric that can easily be manipulated. Wall Street, what are you doing? Capital Markets are the backbone of our entire economy. You want money to be able to flow freely between companies so the market decides who wins. ESG is a small group of elite bankers deciding who wins. That is not free markets.

The best example of this is that Tesla, an electric car company, was recently taken off the list of ESG companies by S&P. This happened right after the CEO of Tesla, Elon Musk, announced his offer to purchase Twitter on April 14. On May 18, Telsa was removed from the S&P 500 ESG Index. Twitter is of course the left-leaning social media website, that has been criticized for censoring news stories like the Hunter Biden laptop. It seems like S&P was trying to take away Elon Musk’s ability to perform the Twitter purchase. As soon as the ESG label gets pulled off a company, all the pension funds that promised they would invest in ESG companies have to immediately sell all Tesla shares of stock.

The reason why S&P looks so hypocritical, is that one of the top ten ranked ESG companies is Exxon Mobil. S&P got rid of an electric car company and included an oil company.

Let us just recap who Exxon Mobil is.

Here is a chart of the number of oil spills by Exxon Mobil from 2005 to 2020, a metric that is not improving. In 2020 they had 223 oil spills.

Dec 23, 2021 Here is an explosion and fire at an Exxon Mobil facility in Texas

Mar 26, 2022 Here is an explosion and fire at an Exxon Mobil facility in Montana

This is the company who is considered ESG, while Tesla is not. I think most people have a hard time understanding that. This comes at tremendous financial cost to Tesla.

Let us look at the rest of the list of the top performers. Apple, Microsoft, Amazon, Google. Amazon? Really? With all those packaging boxes, Amazon is single handedly responsible for creating more trash than almost any other company in the world. Apple? Really? Is this the same Apple whose factories put up nets to keep their workforce from jumping off the buildings and committing suicide because of the inhumane working conditions? That Apple? When we look at this list, it has nothing to do with saving the planet. These aren’t companies that are specifically doing anything environmental or social. These are just big companies. This is what a lot of people do not understand about ESG. This list, is ESG. And to me, this just looks like a list of big companies, patting themselves on the back with your investment dollars. Investors do not realize that ESG does not actually focus on the companies that are cleaning up the environment. There are innovative companies out there who are doing powerful things for the environment, like figuring out how to recycle better, or how to clean up pollution. Those companies are not on this list. For the poor investors who thought that they were saving the planet by investing in ESG, you are not. You are just giving your money to the most powerful people in the world so they can get more rich.

These concerns are labeled with a term called “Greenwashing.” There is enough discretion by the people who give out the ESG label, that they are able to give it to companies that do not deserve it, like Exxon Mobil. It allows the rich and powerful to give money to their friends, and exclude their enemies from the market.

People are now starting to fight back. ESG has become political, and just last week, states like Florida and Texas are now blocking their state fund managers from investing in ESG funds. While I applaud their efforts, I do not think the solution to this is to make it political. We should be getting politics out of capital markets.

There are some simple fixes for this.

  • We need to discontinue “Best-in-class” ratings. The market should decide who is best-in-class.
  • Make ESG a certification with standardized metrics that everyone has the opportunity to obtain
  • Make ESG disclosures standardized but optional for businesses

Leave a comment down below letting me know what you think!

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Neither Zach De Gregorio or Wolves and Finance shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.