A company with a good ESG score pollutes as much as a bad one – 08/01/2023 – Market

Companies that score high on the widely accepted metric of environmental, social and corporate governance (known as ESG) pollute just as much as companies that score low, research has found.

This perverse lack of correlation holds even when companies’ carbon intensity — their carbon emissions per unit of revenue or market capitalization — is compared solely to their environmental score, according to index provider and consultancy Scientific Beta.

“ESG scores bear little or no relationship to carbon intensity, even taking into account only the environmental portion of these scores,” said Felix Goltz, research director at Scientific Beta. “It looks like people haven’t really looked at the correlations. They’re surprisingly low.”

“Reducing the carbon intensity of green portfolios [ou seja, de baixa intensidade de carbono] can be nullified, in practice, by adding ESG objectives.”

The discovery came amid strong demand for ESG investments. So-called “sustainable” funds attracted net investment of $49 billion in the first half of this year, according to Morningstar, while the rest of the fund industry saw outflows of $9 billion.

Goltz and his colleagues analyzed 25 separate ESG scores given by three major agencies: Moody’s, MSCI and Refinitiv.

They found that 92% of the reduction in carbon intensity that investors get by weighting stocks solely by their carbon intensity is lost when ESG scores are added as a partial determinant in the weighting.

Even when using only environmental scores, rather than the full range of environmental and social governance, “the result is a substantial deterioration in green performance,” they concluded.

What’s worse, mixing social or governance scores with carbon intensity often results in portfolios that are less green than the comparable market capitalization weighted index, the researchers noted.

“On average, social and governance scores more than completely reversed the carbon reduction target,” said Goltz.

He offered a simple explanation: that “the correlation between ESG scores and carbon intensity is close to zero (4%). The two goals are unrelated and therefore difficult for investors to achieve simultaneously.”

“It’s very possible that a company with high emissions is very good at governance or employee satisfaction. There is no strong relationship between employee satisfaction or any of those factors and carbon intensity,” argued Goltz.

“Even the environmental pillar doesn’t have much to do with carbon emissions,” he added, as that ranking is determined in part by factors such as the company’s use of water resources and waste management practices.

Keeran Beeharee, vice president of ESG research and disclosure at Moody’s, agrees that investing in ESG does not necessarily help an investor build a low-carbon portfolio or achieve any other specific goal.

“There is a view that ESG assessments accomplish something they do not. ESG assessments are an aggregated product; by their very nature they take into account a range of material factors, so drawing a correlation with one factor it will always be difficult,” said Beeharee.

“In 2015-16, after the SDGs (UN-defined Sustainable Development Goals) and COP21 (the Paris Agreement), when people really started to focus on the climate issue, they quickly realized that an ESG assessment would not have much utility for that and that they needed the right tool for the right task. Today there are more selective tools available that only measure carbon intensity, for example,” he continued.

A spokesperson for MSCI ESG Research said its scores are “primarily intended to measure a company’s resilience to financially concrete environmental, social and governance risks. They are not designed to measure a company’s impact on climate change.”

Its environmental pillar, for example, looks not only at a company’s past carbon emissions, “but also its plans to reduce emissions in the future, its investments to seize opportunities linked to clean technologies, and its management of risks to biodiversity and nature. “,

Refinitiv said that “although very small, the correlation found in this study is not surprising, especially in developed markets, where many large organizations –with sustainability-focused strategies, backed by strong governance, a high degree of awareness of their environmental impact and robust transparency — have good ESG scores, despite the fact that they can also have too great a carbon impact.

Hortense Bioy, Morningstar’s global director of sustainability research, wasn’t surprised by the findings either.

But she finds the research’s focus on trade-offs in sustainable investing useful.

“Investors need to be aware of all the trade-offs,” Bioy said. “It’s not simple. In this case, investors need to reflect on which aspects of sustainability they would like to prioritize when building portfolios: carbon reduction or a high ESG rating.”

This raises the question of whether the ESG concept can actually work as a mass-market product, given that different investors will have different priorities.

“Big investors want to do something custom,” Goltz said. “This is a real problem for crowdfunding schemes like index funds and mutual funds. Even if you have strong ESG considerations, you might disagree with some of the ESG issues,” such as restrictions on the production of certain types of weapons.

And with new metrics, such as biodiversity, being factored into the ESG equation all the time, this problem could get worse, Goltz thinks.

“If you add more unrelated criteria, you’re not going to perform well on all of them, so you have to think about your priorities. If you add too many priorities, you lose focus,” he said.

“If you want to reduce the carbon intensity of your portfolio, the only way to do that is to focus on carbon intensity. Otherwise, before long you’re going to be green diluting.”

Translated by Clara Allain