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Behind the buzz of ESG investing, a focus on tech giants and no regulation

Tapajós river basin, next to Sawré Muybu indigenous land, is home to the Munduruku people, Pará state, Brazil. The Brazilian government plans to build 43 dams in the region. The largest planned dam, São Luiz do Tapajós, will impact the life of indigenous peoples and riverside communities. Dams like these threaten the fragile biome of the Amazon, where rivers are fundamental to regeneration and distribution of plant species and the survival of local flora. Renewable energy, such as solar and wind, holds the key to Brazil’s energy future. Rio Tapajós, na região da Terra Indígena Sawré Muybu, do povo Munduruku, no Pará. O governo brasileiro planeja construir 43 hidrelétricas na bacia do Tapajós. A maior delas, São Luiz do Tapajós, terá impacto sobre a vida dos povos indígenas e comunidades ribeirinhas. Barragens como essas ameaçam o frágil bioma da Amazônia, onde os rios são fundamentais para a regeneração e distribuição de espécies vegetais e a sobrevivência da flora local. Energias renováveis, como solar e eólica, detêm a chave para o futuro energético do Brasil.

  • Despite its exponential growth in the last few years, environment, social and governance (ESG) investment is still very unclear and controversial, which makes it hard to define what it means.
  • According to a study by financial markets data provider Refinitiv, the largest and best-known ESG funds invest most of their clients’ money in big tech companies like Google, Microsoft, Amazon, Apple and Facebook — companies with a small carbon footprint and high returns for shareholders.
  • Some experts say this focus on carbon means the financial market often ignores other ESG issues like data security and labor rights, where big-tech companies have tended to fall short.
  • There are some initiatives, mainly in Europe, to create rules and standards for ESG financial products, but for now, almost any company can be bundled into an ESG index and sold as sustainable.

The idea of responsible investing isn’t new. It was born in the 1970s with religious groups that didn’t want to see their money invested in sectors like weapons, liquor or tobacco. The roots of one type of such investing that began in the 2000s, however, were based on a broader and more appealing concept: ESG, or environment, social and governance.

In 2020, when the CEO of BlackRock — the largest asset manager of the world, with more than $7 trillion under management — put climate change at the center of his traditional letter to CEOs, ESG definitely stopped being a niche concern and entered into Wall Street’s agenda. Now, it’s hard to find a bank or broker that doesn’t have an ESG fund to offer to its clients.

The pandemic has just strengthened this tendency by hitting carbon-intensive sectors hard and encouraging a green economic recovery. Almost every week, a new headline shows how ESG investing has grown. “I have seen charts that range from anything from $800 billion up to $40 trillion,” says Robert Jenkins, head of global research at Refinitiv Lipper, a company from the London Stock Exchange Group that provides financial data and insights to investors and business.

According to Refinitiv’s figures, assets under management in ESG funds leaped from $666.5 billion in 2004 to $3.47 trillion in 2020. That’s a conservative figure when compared with the $30.7 trillion presented in the last report (from 2018) of the Global Sustainable Investment Alliance, formed by sustainable investment organizations around the world. According to Bloomberg, global ESG assets are on track to exceed $53 trillion by 2025, representing more than a third of all assets under management.

“This chart changes over time because a fund would all of a sudden say ‘we will be utilizing an ESG lens in our investment,’ which means nothing,” Jenkins says. “How you categorize funds in an ESG perspective is extraordinarily difficult due to the lack of standardizations.”

But what is behind this ESG excitement? And where is all this money ending up, ultimately? To answer these questions, Jenkins analyzed 28 of the largest and best-known ESG funds in the market. Of these, 12 are active funds — which means they have a portfolio manager with autonomy to choose the companies the fund will invest in — and hold a combined $33 billion. The 16 other funds have $30 billion invested and are passive funds, meaning their portfolios simply mirror an index (a list of companies), like the Dow Jones Sustainability Index, for instance.

Despite having different investment strategies, Jenkins found, both types of funds invest the majority of their clients’ money in a very select group of companies: Microsoft, Google, Apple and Amazon. In the case of passive funds, Facebook also makes the list.

The main reason for the omnipresence of tech giants in ESG funds, according to Jenkins, is that they’re known for having a small carbon footprint.

“All those funds marked themselves as ESG funds or socially responsible funds but they are basically, for the most part, carbon-free funds,” he says.

It also doesn’t hurt, naturally, that these companies have been on a years-long bull run, outpacing market averages and most typical stocks.

A biofuel plant in Piricicaba, São Paulo state, Brazil. Sugarcane is turned into ethanol by fermenting sugarcane juice and molasses. Photo credit: Department of Energy and Climate Change on Flickr.

Long on the E, short on the S and G

A big-tech company, however, isn’t necessarily a low-carbon company. Amazon, for instance, relies on a global transportation and logistics network to deliver all kinds of products, from Kindles and computers to socks, makeup, food and cleaning products.

“So why are they a top-pick? Because people tend to think of them as a tech company and tech companies are assumed to have good carbon footprints,” Jenkins says.

The perception is that tech giants tend to have a smaller carbon footprint than companies in other sectors — or, at least, it’s easier for them to reduce their emissions.

“If you are an oil company, for instance, to reduce your carbon footprint you have to change your product. If you are Google and your data center consumes a lot of energy, you can hire a solar energy system and that is it,” says Gustavo Pimentel from Sitawi, a Brazilian firm that works with investors and companies on sustainable financing.

Tech giants have also made high-profile commitments on the carbon front. Google claims to be the “first major company to be carbon neutral,” saying it did so in 2007. Last year, it announced it would compensate for all its emissions since its founding in 1998, and that it would become carbon-free by 2030. Microsoft says it will be carbon negative by 2030 and will compensate for all the CO₂ it has emitted since its foundation, in 1977, by 2025. Apple, which says it is already carbon neutral for its global corporate operations, says it will do the same across its entire business by 2030, including in its manufacturing supply chain and product life cycle. Amazon says it will be net-zero by 2040, 10 years ahead of the Paris Agreement.

But the focus on carbon may be missing the point. Jenkins says that if greenhouse gas emissions aren’t the main ESG challenge for tech companies — as they would be for an oil company, for example — then they shouldn’t be such a focal point of their ESG ratings. The “S” and the “G” aspects deserve more attention, he says.

“Some of these companies have issues in their promotional and pay practices, and we certainly know that firms like Facebook have some issues in terms of data privacy. So you can argue that maybe they shouldn’t be in these funds,” he says, referring to Facebook’s data leaks and recent controversies over labor relations in the tech industry.

Amazon is facing what the U.S. media calls the biggest union push in its history. Google, routinely named one of the best companies to work for, faces allegations by ex-employees that it unlawfully monitored and fired them due to their union activity. In 2019, a report by the watchdog group China Labor Watch alleged Apple was breaking labor laws at its largest iPhone factory, in China.

Fábio Alperowitch is the portfolio manager at Fama, a Brazilian fund that considers “ethical and ESG principles” in its investment decisions. Like Jenkins, he says this focus on carbon tends to gloss over the other problems.

“If I invest in a construction company, the first thing I need to know as an investor is about the company’s labor security. Each sector has its concerns. When you only think about carbon, the companies will focus on aspects that are not necessarily the most important,” Alperowitch says.

But this position isn’t a universally held one. Gustavo Pinheiro, from Clima e Sociedade, a nonprofit working toward a low-carbon economy, says he welcomes the focus on CO₂ as part of the solution.

“We need all the companies to assume science-based goals and to commit to decarbonize 100% of its productive chains by the half of the century,” he says. By improving their carbon performance, he says, companies end up addressing other aspects of ESG, since they have to revisit their processes, production chains and even their governance. “With climate, you are packaging a lot of things,” Pinheiro says.

Futaleufú River in Chile, where the Spanish energy company Endesa announced in 2016 that it was revoking all claims. Photo by Kaaty.7, licensed under CC BY-SA 3.0.

The math behind ESG

Either way, the experts interviewed for this article agree that the financial market is much more prepared to deal with the climate change issue than with other aspects of the ESG agenda. That’s because, unlike with other aspects of ESG — like biodiversity, water usage, social impact, or deforestation — there’s a universally accepted methodology for calculating and comparing carbon emissions.

“Investors like to quantify stuff,” says Ward Warmerdam, a senior researcher at Profundo, a Netherlands-based nonprofit that works with environmental data. “If you can put a number on it then you can make some kind of a program or calculation to invest in those companies. But, why try to come up with a value to nature?” he says. “Would it give an excuse to destroy nature to a certain extent, as long as we compensate it with another number? I think there is a lot of focus in trying to quantify things while the most important thing is to make sure the companies that you finance aren’t behaving poorly, whatever quantity there is.”

While financial market experts may know a lot about measuring net profits, earnings before interest and other financial figures, they’re still learning how to analyze the environmental and social impacts of investments.

According to Jenkins, most ESG active fund managers rely on outside rating agencies like MSCI or Sustainalytics to decide which companies to include in their portfolios. In the case of passive funds, they mirror well-known social responsibility indexes, like S&P’s ESG Index. Some investment firms, on the other hand, have their own and well-structured ESG analysts teams.

“There are several shops out there, like Calvert, for example, that had really created a specialist team of ESG experts and developed their own internal proprietary rating structures to rank companies by distinctive factors across E, S and G pillars,” Jenkins says. “It is a long process that takes a team of experts. That is also the reason why the prices of these funds may be a little higher.”

While there is no consensus about what ESG is and how to rate companies, almost everything can fit into the ESG box.

“There is no regulator[y] authority internationally monitoring these rating agencies to make sure that they are all doing an equally good job, have similar standards or at least meet a minimal aspect of ESG rating,” Warmerdam says.

“It is really messy and inconsistent. Fortunately, there is more legislation in Europe coming about it,” he adds, referring to the EU Sustainable Finance Disclosure Regulation (SFDR), whose first phase entered into force last month. Through this regulation, all financial market participants and financial advisers will have to explain in detail how they integrate ESG factors into their finance products.

Jenkins says he’s optimistic about improvements in the quality of ESG data as companies come under pressure to disclose more non-financial information.

“As disclosures [become] more homogeneous and standardized, I think that is [going to] drive more alignment and more correlation among rating agencies in ESG,” he says.

The UK’s Drax power station, one of the world’s largest users of forest biomass for energy production. Photo credit: DECCgovuk on VisualHunt / CC BY-ND.

From cookie cutter to impact investing

As the Refinitv study shows, there’s great homogeneity across the investment portfolios of the most well-known ESG funds — the ones Jenkins calls “cookie-cutter” funds.

“They have this broad ESG umbrella framing where they are investing in and they largely invest in well-known securities that are heavily traded on the market, so there is an element of safety in using these funds,” he says.

But the ESG universe goes far beyond these “cookie-cutter” options. MSCI, the world’s largest provider of ESG indexes, has more than 1,500 indexes of this kind. “ESG is very sexy. Just three words that fit in any headline and in the suffix of any fund’s name,” says Sitawi’s Pimentel.

Potential investors in an ESG fund first look at its strategy. Many funds use the negative screening approach, which means they identify certain sectors to rule out. For many years, this no-go list was mainly composed of tobacco, alcohol and weapons makers. More recently, the energy sector has become the biggest villain thanks to its carbon emissions.

Other funds use the best-in-class strategy; instead of excluding sectors, it focuses only on the companies with better ESG ratings in each sector of the economy (energy, utilities, information technology, real estate, etc.). Another possibility is active ownership, when investors use their role as a shareholder to press for ESG improvements, one of several ESG strategies available to investors pushing for change.

“I lean towards what I call a more positive impact investing approach,” says Jenkins, who wrote a guide to help beginners choose an ESG fund. “Instead of negatively screening out all the energy companies, for instance, try to find one that is making meaningful, viable and profitable changes in that space.”

For investors who not only want to avoid companies with negative impacts but also support companies making a positive impact on the world, there’s “impact investing” — funds usually focused on startups and non-listed companies and considered a niche within the ESG investing universe.

Options abound, and the first step for investors should be identifying their priorities when it comes to ESG: global warming, water shortage, gender equality, racism, social inequality, deforestation or something else.

“It is hard to find a security that ticks all E, S and G the boxes very well,” Jenkins says. “And if you have a fund invested only in firms that scored extraordinarily high on all three boxes it probably is going to be a fund with smaller and more innovative companies. You may not want to put the bulk of your money on it because it may be more volatile.”

Despite the challenges and inconsistencies of ESG finance, Warmerdam says it does have the merit of pushing companies in the right direction.

“It is a growing industry and it means that the companies are being pushed to improve their practices on the ground, even if it is slightly indirect,” he says.

Banner image: Tapajós river basin, next to Sawré Muybu indigenous land, is home to the Munduruku people, Pará state, Brazil. The Brazilian government plans to build 43 dams in the region. Photo via Greenpeace.

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