Last week was like the season finale of ‘Elon Musk trolls the world’. ESG has become one of the billionaire’s goals. The pretext was that Tesla was dropping an ESG index.
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ESG is the assessment of companies based on their ability to meet criteria in three key areas:
- social responsibility
- corporate governance
Musk attacked ESG because Tesla dropped out of the S&P 500 ESG Index and companies like Exxon were included in the index. Tesla’s largest shareholder called ESG is a scam that has become a weapon in the hands of fake social activists. It wasn’t the most radical tweet Musk. Is Musk right? No and yes. It depends on how you view the problem. Elon Musk isn’t right on this particular issue with the S&P 500 ESG Index. The idea behind the index is to recreate the sector structure of the S&P 500. This is a basic part of the index methodology. Thus, the structure of the index requires the presence of oil companies within it.
The index methodology largely assumes that the index will include the best ESG oil companies, the best ESG banks and the best ESG automotive companies. Tesla did not lose to Exxon. It lost out to other automakers.
Tesla probably did not lose because of the ecological criterion. We’re not sure because S&P doesn’t provide detailed data for individual companies, but we can guess because other ESG index providers do provide such data. According to Tesla’s ESG assessment prepared by MSCI, Tesla scored 9.1 points out of 10 in the area of ecology, with an industry average of 6.5. In the area of Corporate Social Responsibility it scored 1.4 points against an industry average of 3.5 and in the area of Corporate Governance it scored 5.1 points with an average of 3 .2 in the sector. Thus, Tesla’s low ESG ratings are likely the result of the corporate social responsibility test. Lost cases of racial discrimination, irresponsible approach to health and safety issues, hostile approach to cooperation with authorities in case of inspections and investigations (eg accidents with autopilot on) take their toll here.
Thus, the fact that a company that does a lot to protect the environment, but for example treats its employees badly, may have low ESG ratings is not proof that ESG is useless because ESG consists of of three elements. The ecological criterion is one of the three.
It is also not clear that the approach of the creators of the S&P 500 ESG index is wrong and oil companies should have terrible ratings for ESG, or at least part of the ecological ESG. Two approaches to the ecological criterion in ESG can be considered: absolute and relative.
In a cutthroat approach, oil companies will get terrible marks because their net impact on the environment is terrible. But that’s not the only sensible approach. At this stage of economic and technological development, oil companies are essential. Someone has to extract and process the oil and gas. This can be done in a relatively environmentally friendly way or in a completely unrelated to ecology way (an obvious example may be the approach of burning “unnecessary” natural gas in oil wells) . Measuring relative environmental impact (within the limits of what the industry allows) is the most sensible approach.
So where is Musk, right? In the fact that ESG, despite the aura of impartiality and analytical reliability, is actually a collection of subjective opinions turned into numbers. I think Apple is a perfect example of this – the star of almost every ESG rating.
At the same time, for many years Apple has had one of the most environmentally friendly and anti-consumer approaches to repairing its electronic equipment. In the name of maximizing profits, Apple deliberately destroys the natural environment and impoverishes its customers, doing everything to prevent the repair of even slightly damaged equipment and doing everything to shorten the life cycle of its products. Apple’s corporate dream is for the phone, even with a small defect, to be “commissioned” to the ground (so that no part goes to the secondary market and is used to repair another phone ) and the customer buys another phone and consumes another portion of non-renewable resources.
However, it does not matter that the absolute star of the American stock market is excluded from the ESG indices, hundreds of people take subjective opinions so as not to attach much importance to the approach to product repair. The same may be true of working conditions in subcontractor factories or their use of quasi-slave labour.
For me, ESG ratings are a good illustration of the principle that Seth Godin recently recalled: Just because something seems like a convenient, easy-to-use measure doesn’t mean it’s a useful measure.. ESG ratings are a great measure. Expressed in points, easy to use in comparisons and compilations. Perfect for creating indices based on them and investment products based on these indices (already 35 trillion dollars in assets).
However, their real usefulness is debated. Its evaluation would require access to a detailed methodology which is not available even in the case of relatively transparent providers. Only then will it be clear which specific criteria affect the ESG assessment and which criteria have no effect.
I am convinced that the world and above all The investment industry is full of attractive ratings with dubious or entirely non-transparent methodology and de facto unknown usefulness. They are often an important part of content marketing, have high viral potential. However, I would be careful not to use them in the investment process.
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