Mindless money: why ESG extreme exclusionists should concern investors
Article written by Anthony Edmonds, InvestNow – 31st January 2023
ESG – shorthand for environmental, social and governance – has moved from the fringes of the investment universe to its gravitational centre in less than a decade.
And the concept that investors should take into account a broader range of non-financial factors when assessing company valuations makes intuitive sense: many fund managers likely already incorporated such information long before the ESG label became fashionable.
More recently, retail investors have enthusiastically followed the trend, piling into funds branded as ESG or associated terms such as sustainable, ethical or impact. Catering to the demand, InvestNow offers many ESG-style funds by the likes of Pathfinder, Mint and Harbour – to name but a few.
Again, the retail interest in ESG is a healthy indicator of growing investor engagement with the funds and companies in their portfolios – and investment principles in general.
However, the explosion of ESG funds into the marketplace has also raised flags with regulators across the world amid fears of so-called ‘greenwashing’ – or the mismatch between product claims and real exposures.
Yet despite the best efforts of regulators, notably in the European Union, there is no globally recognised definition of ESG, ethical, sustainable, socially responsible, impact or other similar investment strategies.
Dozens of research firms have stepped into the informational void to offer, often-conflicting, opinions on the ESG-worthiness of companies. Many institutional investors may use data supplied by external researchers – usually supplemented with in-house analysis – to create dedicated ESG products or to simply inform their day-to-day portfolio management decisions.
In practice, most managers will use a mix of exclusion (where portfolios won’t hold certain stocks or securities), engagement (where investors work as shareholders to improve certain aspects of corporate behaviour) or weighting to ‘good’ companies (such as clean energy producers) in their ESG products or strategies. ESG (or comparable) funds exist across a nuanced spectrum of exclusion, engagement and ‘positive impact’ tilts.
Given the fuzzy definitions, cloudy data and disparate real-world practices, investors should be wary of those claiming to own an unbiased source of ESG truth.
The ethical (investment) dilemma
In NZ, for instance, fund recommendation business, Mindful Money, claims to provide “objective information and research to compare the options” in the “ethical investment” sphere.
Using a variety of external data, Mindful Money attempts to map portfolios against a list it has concocted of 10 “issues of concern” (such as gambling and tobacco).
Importantly, though, the criteria underpinning the ‘issues of concern’ definitions are subject to change, which can alter fund classifications in a somewhat arbitrary way on the commission-based sales platform.
Late last year, for instance, the Foundation Series Balanced and Growth Funds (the in-house InvestNow range) saw their purported exposure to ‘issues of concern’ companies jump from about 8% to 14% and 19%, respectively, after Mindful Money tweaked those parameters.
Designed to offer investors low-cost, tax-effective exposure to a broad range of global share and fixed income markets, it’s no surprise that some of the Foundation fund holdings trigger some ESG alarms.
In particular, the Foundation portfolios invest in widely diversified passive index share funds that don’t have many exclusions – the emphasis is on minimising fees and containing tax leakage.
Vanguard acknowledged the conflict between the core investment goal of mainstream index funds to mirror market returns and the increasingly complex ESG demands when withdrawing from the Net Zero Asset Management agreement last December.
“Index fund managers don’t choose the securities in a fund or dictate a portfolio company’s strategy or operations,” Vanguard said in a statement at the time. “Instead, they buy and hold all securities included in the benchmark index and capture the return that the market provides.”
Nonetheless, the fact that the Foundation Series Funds’ alleged exposure to un-ESG companies about doubled following a unilateral decision by Mindful Money to rewrite the ‘issues of concern’ definitions should itself be concerning to investors.
The supposed sin-stock list composed by Mindful Money also captures a surprisingly large portion of the investment universe with more than 200 companies ‘of concern’ including household names, such as Uber, Coca-Cola, Woolworths, Contact Energy and Genesis Energy.
It appears the recent addition of Contact and Genesis to the ‘bad’ pile is based on the NZ electricity generators’ reliance on fossil fuels. For example, Genesis derives 57% of its total power production from non-renewable sources.
While both Contact and Genesis are making efforts to harness more renewable opportunities, it is a cold, hard fact that about 60% of the total NZ energy demand is satisfied by fossil fuels. (Although more than 80% of electricity in NZ already comes from renewable resources, mostly hydro dams.)
If Genesis immediately switched off the coal-powered Huntley power station simply to appease ‘concerned’ investors, the real-life repercussions for NZ citizens would be disastrous.
At the same time, if investment managers acted en masse to divest from Contact and Genesis on a spurious designation as ‘companies of concern’ by Mindful Money, the consequences for all stakeholders would be dire – especially the NZ public.
Furthermore, excluding companies based on fossil fuel use would ultimately scrub many of the large listed NZ companies – Mainfreight, Air NZ, A2 and Fonterra, to name a few – from the index.
Logically, extending the Mindful Money exclusion rationale might even see the NZX50 whittled down to the NZX5, dramatically cutting investor diversification and starving key parts of the local economy of capital.
Good is bad (and vice-versa) at the limits
As the NZ example shows, pursuing a purist fossil fuel exclusion policy opens up a series of complex – and likely unanswerable – questions for investors.
But if designing a portfolio around the relatively narrow constraints of fossil fuels is problematic enough, the concept of a one-size-fits-all ‘ethical’ investment strategy verges on insanity.
Firstly, there is no universal agreement on the definition of an ‘ethical’ company. As discussed earlier, ESG data suppliers often take different views on the same company: renewable energy poster-child, Tesla, for instance, and ExxonMobil – one of the world’s largest oil producers – can be found on both pro- and anti-ESG rankings.
Drawing a hard line between ‘good’ and ‘bad’ firms will also lead investors down a definitional rabbit-hole of almost infinite proportions.
Say, for example, a firm’s main supplier has a large carbon footprint – does the association with an ‘unsustainable’ third-party rub-off on all those associated with it? If so, the entire corporate world would likely fall into ‘unethical’ territory.
Fund managers must – and do – put limits on their definitions of ESG and/or ‘ethical’, which is fine as long as those rules are clearly disclosed and understood by investors.
Regulators are also beginning to police the ESG definitional grey zone as Vanguard Australia discovered late last year. The Australian Securities and Investments Commission (ASIC) handed Vanguard an almost symbolic fine of about A$40,000 for alleged breaches of ‘greenwashing’ regulations.
According to ASIC, the Vanguard International Shares Select Exclusions Index Fund – a popular choice on InvestNow – may have mislead investors with claims it excluded tobacco companies because some of the companies in the portfolio derived income from the sale of tobacco products.
The ASIC action against Vanguard highlights an important truth about how managers, researchers and others make the call on the ESG qualities of underlying investments based on a defined threshold of exposure to certain business activities.
Consider the case of discount supermarket chain, Costco, which is probably one of the largest alcohol retailers in the world, selling roughly US$6.5 billion of beer, wine etc each year. However, the Costco booze sales amount to just 3% of the firm’s annual revenue of about US$220 billion, which falls outside the 5% alcohol corporate income threshold for exclusion set by another Vanguard product – the Ethically Conscious International Shares Index Fund.
Technically, investors in the Vanguard Ethically Conscious International Shares Index Fund – a strategy used by many KiwiSaver providers such as Simplicity – can claim ‘we don’t invest in companies with significant exposure to alcohol’ based on the product definition. By absolute measures, though, those Ethically Conscious investors own a piece of one of the biggest global purveyors of alcohol.
The point is not to single out Vanguard – which is a highly professional investment firm attempting to build ESG-compliant products around complex, and ever-moving, criteria – but to illustrate why investors need to question simplistic claims of ethical superiority issued by unlicensed researchers who have never managed money nor are accountable for the investment outcomes (such as poor diversification) of their pseudo-advice.
Despite the confusing, and potentially dangerous, focus on black-and-white moralising by extreme exclusionists, ESG remains an important development in the funds management industry; a change InvestNow fully supports with a growing range of products offered by reputable regulated managers who are best-placed to shape the ESG future.
ESG, however, is not well-served by those who mindlessly create ever-expanding lists of ‘bad’ companies that – if followed to a logical conclusion – would bar investors from virtually all securities while doing nothing, or less, to achieve a better future for the world.
Mindless money: why ESG extreme exclusionists should concern investors
Article written by Anthony Edmonds, InvestNow – 31st January 2023
ESG – shorthand for environmental, social and governance – has moved from the fringes of the investment universe to its gravitational centre in less than a decade.
And the concept that investors should take into account a broader range of non-financial factors when assessing company valuations makes intuitive sense: many fund managers likely already incorporated such information long before the ESG label became fashionable.
More recently, retail investors have enthusiastically followed the trend, piling into funds branded as ESG or associated terms such as sustainable, ethical or impact. Catering to the demand, InvestNow offers many ESG-style funds by the likes of Pathfinder, Mint and Harbour – to name but a few.
Again, the retail interest in ESG is a healthy indicator of growing investor engagement with the funds and companies in their portfolios – and investment principles in general.
However, the explosion of ESG funds into the marketplace has also raised flags with regulators across the world amid fears of so-called ‘greenwashing’ – or the mismatch between product claims and real exposures.
Yet despite the best efforts of regulators, notably in the European Union, there is no globally recognised definition of ESG, ethical, sustainable, socially responsible, impact or other similar investment strategies.
Dozens of research firms have stepped into the informational void to offer, often-conflicting, opinions on the ESG-worthiness of companies. Many institutional investors may use data supplied by external researchers – usually supplemented with in-house analysis – to create dedicated ESG products or to simply inform their day-to-day portfolio management decisions.
In practice, most managers will use a mix of exclusion (where portfolios won’t hold certain stocks or securities), engagement (where investors work as shareholders to improve certain aspects of corporate behaviour) or weighting to ‘good’ companies (such as clean energy producers) in their ESG products or strategies. ESG (or comparable) funds exist across a nuanced spectrum of exclusion, engagement and ‘positive impact’ tilts.
Given the fuzzy definitions, cloudy data and disparate real-world practices, investors should be wary of those claiming to own an unbiased source of ESG truth.
The ethical (investment) dilemma
In NZ, for instance, fund recommendation business, Mindful Money, claims to provide “objective information and research to compare the options” in the “ethical investment” sphere.
Using a variety of external data, Mindful Money attempts to map portfolios against a list it has concocted of 10 “issues of concern” (such as gambling and tobacco).
Importantly, though, the criteria underpinning the ‘issues of concern’ definitions are subject to change, which can alter fund classifications in a somewhat arbitrary way on the commission-based sales platform.
Late last year, for instance, the Foundation Series Balanced and Growth Funds (the in-house InvestNow range) saw their purported exposure to ‘issues of concern’ companies jump from about 8% to 14% and 19%, respectively, after Mindful Money tweaked those parameters.
Designed to offer investors low-cost, tax-effective exposure to a broad range of global share and fixed income markets, it’s no surprise that some of the Foundation fund holdings trigger some ESG alarms.
In particular, the Foundation portfolios invest in widely diversified passive index share funds that don’t have many exclusions – the emphasis is on minimising fees and containing tax leakage.
Vanguard acknowledged the conflict between the core investment goal of mainstream index funds to mirror market returns and the increasingly complex ESG demands when withdrawing from the Net Zero Asset Management agreement last December.
“Index fund managers don’t choose the securities in a fund or dictate a portfolio company’s strategy or operations,” Vanguard said in a statement at the time. “Instead, they buy and hold all securities included in the benchmark index and capture the return that the market provides.”
Nonetheless, the fact that the Foundation Series Funds’ alleged exposure to un-ESG companies about doubled following a unilateral decision by Mindful Money to rewrite the ‘issues of concern’ definitions should itself be concerning to investors.
The supposed sin-stock list composed by Mindful Money also captures a surprisingly large portion of the investment universe with more than 200 companies ‘of concern’ including household names, such as Uber, Coca-Cola, Woolworths, Contact Energy and Genesis Energy.
It appears the recent addition of Contact and Genesis to the ‘bad’ pile is based on the NZ electricity generators’ reliance on fossil fuels. For example, Genesis derives 57% of its total power production from non-renewable sources.
While both Contact and Genesis are making efforts to harness more renewable opportunities, it is a cold, hard fact that about 60% of the total NZ energy demand is satisfied by fossil fuels. (Although more than 80% of electricity in NZ already comes from renewable resources, mostly hydro dams.)
If Genesis immediately switched off the coal-powered Huntley power station simply to appease ‘concerned’ investors, the real-life repercussions for NZ citizens would be disastrous.
At the same time, if investment managers acted en masse to divest from Contact and Genesis on a spurious designation as ‘companies of concern’ by Mindful Money, the consequences for all stakeholders would be dire – especially the NZ public.
Furthermore, excluding companies based on fossil fuel use would ultimately scrub many of the large listed NZ companies – Mainfreight, Air NZ, A2 and Fonterra, to name a few – from the index.
Logically, extending the Mindful Money exclusion rationale might even see the NZX50 whittled down to the NZX5, dramatically cutting investor diversification and starving key parts of the local economy of capital.
Good is bad (and vice-versa) at the limits
As the NZ example shows, pursuing a purist fossil fuel exclusion policy opens up a series of complex – and likely unanswerable – questions for investors.
But if designing a portfolio around the relatively narrow constraints of fossil fuels is problematic enough, the concept of a one-size-fits-all ‘ethical’ investment strategy verges on insanity.
Firstly, there is no universal agreement on the definition of an ‘ethical’ company. As discussed earlier, ESG data suppliers often take different views on the same company: renewable energy poster-child, Tesla, for instance, and ExxonMobil – one of the world’s largest oil producers – can be found on both pro- and anti-ESG rankings.
Drawing a hard line between ‘good’ and ‘bad’ firms will also lead investors down a definitional rabbit-hole of almost infinite proportions.
Say, for example, a firm’s main supplier has a large carbon footprint – does the association with an ‘unsustainable’ third-party rub-off on all those associated with it? If so, the entire corporate world would likely fall into ‘unethical’ territory.
Fund managers must – and do – put limits on their definitions of ESG and/or ‘ethical’, which is fine as long as those rules are clearly disclosed and understood by investors.
Regulators are also beginning to police the ESG definitional grey zone as Vanguard Australia discovered late last year. The Australian Securities and Investments Commission (ASIC) handed Vanguard an almost symbolic fine of about A$40,000 for alleged breaches of ‘greenwashing’ regulations.
According to ASIC, the Vanguard International Shares Select Exclusions Index Fund – a popular choice on InvestNow – may have mislead investors with claims it excluded tobacco companies because some of the companies in the portfolio derived income from the sale of tobacco products.
The ASIC action against Vanguard highlights an important truth about how managers, researchers and others make the call on the ESG qualities of underlying investments based on a defined threshold of exposure to certain business activities.
Consider the case of discount supermarket chain, Costco, which is probably one of the largest alcohol retailers in the world, selling roughly US$6.5 billion of beer, wine etc each year. However, the Costco booze sales amount to just 3% of the firm’s annual revenue of about US$220 billion, which falls outside the 5% alcohol corporate income threshold for exclusion set by another Vanguard product – the Ethically Conscious International Shares Index Fund.
Technically, investors in the Vanguard Ethically Conscious International Shares Index Fund – a strategy used by many KiwiSaver providers such as Simplicity – can claim ‘we don’t invest in companies with significant exposure to alcohol’ based on the product definition. By absolute measures, though, those Ethically Conscious investors own a piece of one of the biggest global purveyors of alcohol.
The point is not to single out Vanguard – which is a highly professional investment firm attempting to build ESG-compliant products around complex, and ever-moving, criteria – but to illustrate why investors need to question simplistic claims of ethical superiority issued by unlicensed researchers who have never managed money nor are accountable for the investment outcomes (such as poor diversification) of their pseudo-advice.
Despite the confusing, and potentially dangerous, focus on black-and-white moralising by extreme exclusionists, ESG remains an important development in the funds management industry; a change InvestNow fully supports with a growing range of products offered by reputable regulated managers who are best-placed to shape the ESG future.
ESG, however, is not well-served by those who mindlessly create ever-expanding lists of ‘bad’ companies that – if followed to a logical conclusion – would bar investors from virtually all securities while doing nothing, or less, to achieve a better future for the world.
We would welcome an opportunity to respond to this criticism of Mindful Money as a blog post. In the meantime, here are a few points to set the record straight.
Most investors want to know which companies their fund invests in but until now it has been impossible to find out. Now they can. Mindful Money is a charity that provides this information, free to consumers. We need more transparency not less, even if it makes some fund mangers uneasy when their investments are exposed.
As the blog says, we relate the investments to ‘companies of concern’. We don’t make those up. They are the issues that consumers say they want to avoid, measured through annual market research. Mindful Money consults widely on the definitions of those issues, and we recently received supportive comments to proposed changes from the majority of fund managers in New Zealand (BTW, we don’t list fossil fuel users like Mainfreight, Air NZ, A2 and Fonterra as suggested by this blog). Our methodology is published in detail on our website.
We recognise there are different strategies in order to manage ESG issues. Almost all fund managers will exclude some companies (like tobacco and deadly weapons). Others extend their exclusions to cover issues like gambing, pornography, weapons or companies that violate human rights, in response to consumer demand. Many consumers feel passionate about those issues and don’t want their money to be invested in companies that do harm.
Other fund managers engage with the funds they invest in to try to improve their performance. That is a valid approach, and best practice fund managers identify the changes they achieve through stewardship. Mindful Money supports good practice stewardship through educational guides, our seminar series and annual awards. And we are supportive of those funds that invest in companies that are supporting the transition to net zero and issues like social housing and renewable energy. A growing number of consumers want to invest in those funds.
I think the InvestNow platform provides a great service, but it would be good to have a better quality of debate in this blog.
Barry Coates, Founder and CEO of Mindful Money
It is quite disappointing to read this article by InvestNow. The negative attitude towards ESG risks alienating ethical investors from the InvestNow platform as it makes you wonder whether InvestNow’s values align with ethical investing. I wholeheartedly agree with Barry Coates that we need more clarity, not less, in the space of ESG and SRI investing, and Mindful Money has done a great job at providing this for New Zealanders. This article leaves the impression that InvestNow is mainly critisising Mindful Money because the Foundation Series Funds did not get a great rating recently, and that is not a very constructive attitude.
I certainly agree that ethical investing is not (and should not be) just about excluding certain funds or companies. It is also about positive investments, supporting those companies that go the extra mile or are early adopters when it comes to climate change, equity, human rights and other ethical factors. If Contact and Genesis are worried about losing investors to more proactive, less fossil fuel dependent companies, maybe that will encourage them to increase their efforts towards producing green energy and cutting carbon emissions. This is what impact investing is about: using money to make change happen, via investments that make the world a better place. And yes, what ‘better’ means is difficult to agree on, but a lot of work has already happened in this space. It would be good to take a closer look at the field of impact investing where a more thorough approach is applied.
But maybe this article is a good sign: ethical investing is no longer a niche phenomenon , rather a force to be reckoned with. It makes the traditional funds and platforms nervous, because so many investors demand change, for the better, and these investors actually have some leverage. Pathfinder for example, whose funds are also offered on InvestNow, has proven that ethical investing and high returns can go hand in hand, and have seen their client numbers grow exponentially over the last 5 years. I hope impact investing will see further exponential growth in the next decade. So consider wisely InvestNow, which side you choose to be on.
Hi Tania
We are huge supporters of ESG and super excited about the growth investment options that we can provide our clients with.
The article wasn’t being negative towards ESG, rather it was to generate debate as to whether companies like Contact and Genesis should be labelled as “companies of concern”.
Regards, Anthony Edmonds
InvestNow
I have been in email discussions with Nikko and they are generally supportive of ESG. I contacted them out of concern for one of the Corporate Bond Funds I invest in. While there are guiding principles of ESG its probably still up to the individual investor to decide on their own ESG requirements and what they deem to be a suitable investment for their own objectives. I am doing this as part of my asset portfolio I am building for myself. I am currently looking to move my money into a new bond fund. The one I am currently in has ASB bank as one of the corporations in the fund. But they don’t comply with ESG based on my principles. ASB bank in New Zealand discriminate against bankrupts and other marginalised members of society. They do that by forcing the closure of transactional bank accounts against people they deem undesireabe. In my case even though I never held debt with ASB they still would not allow me to open a transactional bank account with them because of my financial situation. And they have made it clear they are not going to change anytime soon. If even one business in a fund is not operating in ways that I deem acceptable (in this case discrimination), then that fund won’t be included in my portfolio. Simple. I don’t want my money going to a bank who has policies that cause harm and distress to others.