Is It Time to Dump ESG?

In 2015, the United Nations adopted a list of 17 sustainable development goals, known as SDGs, intended to drive policies that would end all forms of poverty, fight inequality, and battle climate change. A key point was that reaching these goals would leave no one behind. The U.N. had hoped to accomplish these goals by 2030.

A report released Thursday morning by Util, a data provider that measures the environmental and social impact of companies and investment portfolios, questions the basis of environmental, social, and governance investing, declaring that “there are few obvious, absolute ‘good’ or ‘bad’ investments” after analyzing more than 6,000 U.S. funds purporting to adhere to the U.N.’s sustainability goals.

Util used natural language processing to evaluate U.S. funds to determine the relationships between a fund and the 17 SDGs, the 169 sub-goals, and some 2,000 underlying concepts. The researchers used the results to identify 10 leaders and 10 laggards meeting the SDGs.

One of the key recommendations of the report is that it is time to “unbundle” environmental, social, and governance metrics because each “represents a suite of different, even conflicting, objectives.” Using a catchall concept like ESG “obscures valuable information and misdirects [financial] flows.” Util likens ESG to Schrödinger’s famous cat, trapped in a box with a poison that will be released if a radioactive atom decays. Until the box is opened, the cat is both dead and alive, a version of a quantum mechanics concept known as superposition. Similarly, ESG is a catchall phrase that isn’t determined until investors open the box by opening their wallets.

Another key finding is that the transition to green energy development is not without tradeoffs. Calling the transition to a low-carbon economy a “case study in sustainability tradeoffs,” the report notes that mitigating climate change includes both more renewable energy development and more environmentally damaging practices like mining and waste dumping. Interestingly, the Util report found no laggard to the seventh SDG, which calls for universal access to affordable, reliable, sustainable, and modern energy.

The third key finding of the report is that “ESG is biased towards large companies with reporting  resource and against those in developing markets, due to perceived social and governance flaws and straightforward data gaps.” Poor countries bear less responsibility for climate change but are more affected by its effects. Investing in developing markets “has a far higher relative positive impact” on reducing poverty and improving people’s lives. Util cites a report published in June which found that “the growing role of environmental, social and governance (ESG) considerations in institutional investors’ allocation strategies may risk diverting capital flows away from emerging and frontier markets.”

Many of Util’s assessments directly support the contentions of The Corporate Citizenship Project, a corporate governance think-tank focused on common sense reform to matters relating to ESG. The Corporate Citizenship Project has often critiqued ESG ratings agencies for a lack of transparency and for choosing metrics that are not directly correlated with societal good.

One company frequently critiqued by The Corporate Citizenship Project is proxy-voting advisor Institutional Shareholder Services. Institutional Shareholders Services uses 15 of the SDGs in its ESG sustainability evaluations. Among these is alleviating poverty, No. 1 on its list of social objectives. The U.N.’s SDGs include, at the top spot, ending poverty in all its forms, everywhere. Alleviating poverty is not the same as eradicating it.

ISS in its report on navigating ESG in 2022 said the firm conducted 282 “controversies-based engagements” over the past three years on 495 different ESG topics. Of those engagements, ending poverty ranked 10th with about 25 engagements. The most discussed subject was SDG 16, peace, justice, and strong institutions. The second most-discussed was SDG 8, decent work, and economic growth. Not included among the top 10 was SDG 2, zero hunger, even though “combating hunger and malnutrition” is also among ISS’ 15 sustainability objectives.

According to Bryan Junus, Chief Analyst for The Corporate Citizenship Project, ESG activists often use lofty language but fail to hold companies accountable for promises.

“Our understanding is that ESG ratings firms regularly favor companies who make large long-term commitments to addressing global issues. However, it is extremely difficult to hold a company accountable for long-term promises. The result is a deceptive industry that wows investors with promises of carbon-neutrality and poverty-elimination while delivering very few measurable results towards those ends.”