We all know that the merits of many environmental, social and governance (ESG) criteria are pretty subjective. You just need to look at the correlation of ESG scores for companies across different ratings providers to see how even those dedicating vast resources to the topic have wildly differing views.
A study by MIT Sloan School of Management last year found a correlation of just 0.61 between the six most prominent ESG rating agencies, highlighting the fact that scores across providers have a relatively weak relationship with each other. In comparison, credit rating agencies shared a much stronger correlation of 0.92.
The result is that fund managers have a lot of wiggle room when marketing a fund on its ESG credentials. And just because a fund calls itself an ESG fund, that doesn’t mean its non-financial qualities are necessarily any more virtuous than those of an unbranded counterpart.
Lots of ESG funds have been pulled up accordingly. A damning report by London-based climate change think tank InfluenceMap published in August found that the majority of climate-themed funds fell short on their alignment to the Paris Agreement, which called on countries to do their best to reduce emissions to keep global temperatures at less than 2°C above pre-industrial levels – and preferably no higher than 1.5°C.
In its ‘broad ESG’ category, the research found that 71 per cent of nearly 600 funds were misaligned from the Paris treaty as they had a negative Paris Alignment score (as measured by the PACTA tool, managed by the 2 Degrees Investing Initiative).
In the climate-themed category of 130 funds, Paris Alignment scores ranged from -42 per cent to +90 per cent. But even in this category, the majority of funds were found to be misaligned, with around 55 per cent receiving negative scores.
While the report found that ‘clean energy’ funds tended to perform well on climate matters, funds marketed as 'fossil fuel restricted,' on average, show little variation from broader market indices. “Notably, these funds commonly retain holdings in oil and gas value chain companies which do not directly own reserves, such as refiners and distributors, as well as problematic holdings in non-fossil fuel production sectors,” the report says.
Among climate-themed funds offered by the world’s largest asset managers, State Street, UBS Group and BlackRock were found to be the worst offenders. iShares Developed World Fossil Fuel Screened Equity Index Fund (GB00BFK3MT61), for example, holds shares in the large US refiners Marathon Petroleum Corporation (US:MPC) and Phillips 66 (US:PSX). InfluenceMap says that these are two large fossil fuel lobbying companies preventing policy-based climate action.
Research by SCM Direct last month analysed 343 UK registered funds with a ‘Sustainable Investment’ focus and found that 10 per cent of these funds have a worse corporate sustainability score than the average of their conventional peers.
The paper highlights that Royal London UK Core Equity Tilt Fund (GB00B523MH29), which seeks to achieve carbon intensity of at least 10 per cent and up to 30 per cent lower than that of FTSE 350 Index, fails miserably to achieve this. According to MSCI, its carbon intensity is 138.7 tons, which is less than 1 per cent lower than that of iShares 350 UK Equity Index Fund (GB00BCDPB358).
