‘Sustainable’ Investing Is a Self-Defeating Strategy

If, say, oil stocks sell at low prices relative to earnings and prospects, those who buy them stand to gain.

By Burton G. Malkiel. Excerpts:

"ESG rating agencies supposedly fulfill the need by providing composite scores. These agencies range from specialized firms like Sustainalytics to large index providers such as MSCI. Business is booming, and these agencies are increasingly influential in determining how capital is allocated. The problem is that the scores from different providers disagree dramatically. Moreover, ESG ratings tend to be divorced from considerations of how environmental, social and governance performance can influence future financial results.

ESG raters can’t even agree on how to evaluate these companies when they consider the same attribute such as carbon intensity. Some examples will illustrate how difficult this can be.

Xcel Energy has one of the biggest carbon footprints in the electric utility industry. Xcel ranks poorly because it generates a substantial share of its power from coal. But Xcel is the first U.S. utility committed to going 100% carbon-free by 2050 and is a leader in building wind-generation facilities. Should we refuse to invest because of its carbon emissions, or do we approve of the company because of responsible investments that may ultimately lead to greater profitability?

Another example is Kinder Morgan, a gas pipeline company, which scores poorly for investors who eschew carbon-intensive energy. But natural gas is the cleanest-burning carbon, and to the extent that it can replace coal, environmental goals can be better achieved. And it is far safer to transmit gas through pipelines than by rail or truck.

Disagreements regarding ratings can be even more prevalent in industries with relatively low carbon intensity. Bank of America gets a below-average ESG score from one rating agency and a well-above-average rating from another. These disagreements arise because raters differ on how to measure and weigh ESG attributes. Raters are also influenced by their views of the company as a whole. As a result, there are large differences in individual ESG ratings for Intel, GlaxoSmithKline, Comcast, Pfizer and Samsung."

"If carbon footprint is a major factor in excluding companies from an ESG portfolio, what kinds of companies are favored for investment? In the top holdings for the largest ESG mutual funds, we find Alphabet (Google’s parent) and Facebook, as well as Visa and MasterCard, prominently featured. These companies have had their share of controversies. Would all ESG investors really have their social consciences assuaged by investing in companies found to breach individual privacy or that impose exorbitant interest rates?"

"During particular periods, some funds with specific ESG mandates have outperformed. In the first half of 2020 funds with no oil but high tech stocks did well as the price of oil plummeted and tech stocks soared. But no credible studies show that ESG investing offers consistently higher long-term returns."

"ESG investing is inherently at odds with the goal of earning higher returns."

"It isn’t easy to do well by doing good, and ESG funds may accomplish neither objective."