If Tesla’s Out And Exxon’s In, What Really Qualifies As ESG?
On April 22, S&P Global announced the results of its annual rebalance and removed Tesla from its S&P 500 ESG Index. The change received immediate pushback from Tesla CEO Elon Musk, who took to Twitter to call ESG a “scam.” ARK Investments Chief Investment Officer and prominent Tesla supporter Cathie Wood responded with her own tweet, calling the decision “ridiculous.”
The tweets have induced countless responses from those involved in the ESG investing space, not because ESG isn’t without its failures that deserve serious critique (i.e. greenwashing), but mostly because ESG is not one, finite thing.
Rather, the three-letter acronym encapsulates many things:
- Gathering data from complex corporate behavior related to environmental, social, and governance issues.
- Various quantitative and qualitative assessments of that data.
- Countless applications of those assessments, from the creation of “ESG” indices to varied investment methodologies.
From there, investors may then have different reasons for following ESG approaches. For some, it’s about deeply held personal values. For others, it’s about pragmatically reducing ESG-related risks (like, say, the governance risks related to a CEO trying to take over a public company unrelated to his own company, and how that affects his company’s stock price).
But when nuance is hard to follow, people look for an easy, clear-cut explanation. ESG’s inherent complexity has made it an easy target for flippant attack. ESG’s attention from billionaire CEOs and senior politicians means one thing for sure: Investors’ ability and choice to make more values-aligned (and risk-reducing) investing decisions has struck a nerve. But as the attacks muddy the waters for investors, the financial services industry (and its related media) has an increasing responsibility to provide broader context and education.
“ESG” has three letters
The “E” stands for “environmental,” and sometimes people believe that’s the sole focus of ESG investing. From that perspective, seeing Tesla’s removal from an ESG index might seem preposterous. But, as S&P explained, “while Tesla may be playing its part in taking fuel-powered cars off the road, it has fallen behind its peers when examined through a wider ESG lens.”
Through Tesla, Musk has catalyzed the monumental shift away from gas-powered internal combustion engine vehicles, paving the way for a lower-carbon future. But for investors assessing risk, there are not just other environmental considerations, but the two other letters to consider. The company has been in the news for alleged racism and poor working conditions at its factory in Fremont, California. Black Tesla employees describe a culture of racism, including racist slurs and discriminatory behavior, on top of mandatory 12-hour shifts, six or seven days a week.
Meanwhile, Musk as the CEO and largest shareholder of Tesla presents unique governance risks for the company and its shareholders. While his unbridled leadership has clearly created enormous value, that level of autonomy also inherently ties his personal, public behavior to the company’s stock price. That behavior, to put it mildly, is not always even-keeled.
Discounting these realities can and has cost investors. Factoring them into investment decisions? That’s ESG investing.
An Index is Still an Index
As Musk and others made a point to highlight, S&P dropped Tesla and yet added Exxon Mobil to the index. But this overlooks the most critical point of context: S&P’s ESG index still tracks the sector weights of the overall S&P 500. While the index screens out more egregious energy product involvements like thermal coal and oils sands, by design a traditional oil & gas allocation must be included to track the broad market. S&P isn’t representing that its index only includes the best ESG performers, but that it arguably includes stronger ESG performers on a sector peer-relative basis. In fact, while S&P added Exxon, they removed Chevron, arguing that Exxon has become a better leader in carbon transition among traditional fossil fuels companies.
For investors, tracking such an ESG index is one option in the broad spectrum of ESG investing approaches. Some investors might prefer using an index to capture peer-relative ESG integration while maintaining broad exposure to all sectors. Others may prioritize deeper ESG integration over sticking to traditional sector exposures. But that’s the point: There is no end-all-be-all version of ESG, and its implementation should depend on the priorities of each investor.
How Can Advisors Find an ESG Path Through the Noise?
Advisors have more tools than ever to cut through the noise. But it’s important that they know where to start.
First, with 80-90% of investors wanting to align portfolios with their values, advisors need to more deeply understand their investors’ priorities, not just risk tolerance. That deeper understanding will then lead to the appropriate investment solution.
Next, when it comes to evaluating investment solutions, advisors should look for those that are constructed using more than just a single ESG data set. Since there are no clear standards around how providers measure and report ESG data, a provider like S&P may present an ESG assessment of a company that’s different from other providers. ESG data to some extent will forever remain subjective. How do you assign a quantified level of governance risk to Elon Musk’s behavior, for example? And yet if such issues matter to an investor, either for the sake of values-alignment or practical risk reduction (or some combination of both), it’s up to advisors to determine how to incorporate the data.
Thankfully, technology can make it easier for advisors to both uncover investors’ values and confidently tie them to investments that match. Seeds empowers advisors with technology to capture a multidimensional understanding of investor needs, from risk tolerance to values priorities. And our software incorporates various data sources to create a “consensus” ESG assessment across companies, and then uses that framework to automatically construct portfolios.
As ESG increasingly makes headlines, advisors will need to know the difference between sensationalism and reality. While ESG investing may feel complex, advisors can focus on better understanding what really matters most to their clients.
Note: Tesla does not meet Seeds’ rules framework because of its product governance and related risk exposure sits above threshold levels.
