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New York (CNN Business)ESG investing — funds that are conscious of companies’ actions on the environment, society and governance — is an increasingly popular trend for people concerned about how their money is being used. It sounds great, but it’s complicated.
The ESG label is meant to make investing green easier by giving investors a simple way to allocate their money to good causes. And, indeed, there are plenty of sustainability- and climate change-focused exchange traded funds available.
But it’s still not the catch-all stamp of approval you’d expect.
The label started with the idea that ESG issues should be included when valuing a business. More recently, however, the emphasis has moved to the impact company’s products and services have, said Jon Hale, director of sustainability research at Sustainalytics.
“A lot of ESG funds are oriented more toward the ESG valuations rather than the impact,” he told CNN Business.
That’s why the blanket ESG designation might not mean all companies in an ETF are up-to-snuff on all fronts.
“You can’t tell just from the label. You actually have to figure out what they’re doing,” said Hale.
That essentially forces investors into tough choices between the E, the S and the G. Invest in one, and you often have to sacrifice another. This puts climate and socially conscious investors in a tough spot.
Problem 1: Big Tech
For example, ESG ETFs stay away from weapons manufacturers, tobacco companies or firms in the coal and oil sands businesses but still give investors access to the controversial golden geese of America’s stock market: tech stocks.
Big Tech companies like Apple (AAPL) and Amazon (AMZN) make up a big chunk of these funds. They’re included because both of these companies have made commitments to run net-zero carbon supply chains and operations in the next decades.
That doesn’t mean they’re carbon-neutral now. Amazon’s ultra-fast delivery options come at an environmental cost, for example. Last year, when online shopping went through the roof as people tried to avoid exposure to Covid-19, Amazon’s carbon emissions grew by 19% — even though the business reduced its overall carbon intensity.
As for Apple, though the company is working on getting the carbon intensity out of its mostly Asia-based supply chain, it’s not there yet. Apple’s manufacturing contributed more than two-thirds of its carbon footprint last year, according to the company’s environmental progress report. Apple also includes the use of its products by consumers in the company’s carbon footprint, which accounts for another one-fifth.
Both Apple and Amazon particularly struggle with the S and the G as well: They continue to face scrutiny over the treatment of their Chinese factory and essential warehouse workers, for example. Amazon has been criticized for blocking employee efforts to form unions.
Facebook (FB) is also represented in ESG funds, despite the criticism from governments and individuals about the company’s impact on society.
Problem 2: Tesla
Another mainstay in thematic ESG funds is electric car maker Tesla (TSLA).
From an emissions point of view, electric cars are an obvious choice for a climate-conscious investor. But electricity that fuels electric cars is still generated using natural gas or coal, and the environmental impact of battery production is less well known. That’s leaving a coal stain on Tesla’s China expansion.
Also hurting Tesla’s record: the company’s history of making billions on selling regulatory credits to other car markers, allowing them to keep making money on gas-fueled vehicles.
“Everything is a tradeoff,” said Elizabeth Levy, portfolio manager at Trillium Asset Management told CNN Business, and consuming anything, by definition, is using up some resource. But while we might not know as much about battery production as about the impact of oil extraction, batteries still win the direct comparison, Levy said.
Tesla has reduced its carbon footprint every year for the past decade, said Dan Ives, analyst at Wedbush Securities, who covers the company.
But the environment isn’t Tesla’s only issue. CEO Elon Musk, who spent much of the pandemic denying the risks of Covid-19 and railing against lockdown orders, also has plenty of governance problems, too. Musk has gotten punished multiple times by the Securities and Exchange Commission for his misleading tweets and other violations.
Most recently Musk stirred things up on social media and on television about cryptocurrencies, which moved the market sharply. Tesla also disclosed it invested millions in Bitcoin — only to later say it canceled plans to accept the cryptocurrency as payment because of its immense carbon footprint.
“Trying to find the perfect company is impossible,” said Ives. “Realistically, no company is going to check every box. But if there are five boxes and [a company] checks four, that’s significant.”
Problem 3: New technologies, new problems
Bitcoin and other new technologies are part of a new ESG issue: an insatiable hunger for electricity.
The same power needed to charge zero-emissions vehicles is required to fuel the Bitcoin mining process, in which computers solve complex puzzles to create new “blocks” on the blockchain and thus unlock new coins. Bitcoin has come under fire over environmental concerns regarding the high energy use of the mining process.
Natural gas, a common source of energy for electricity in the United States, is less polluting than oil from an emissions point of view, but much of the world still burns coal to fuel power plants, which is weighing on the effectiveness of on climate-friendly alternatives like electric vehicles as emissions savers.
For ESG investors this raises the question what environmentally friendly technologies are actually green through and through.
Batteries are another such conundrum because they use other nonrenewable resources, materials that are found in only a handful of places on earth, such as lithium and cobalt.
The Democratic Republic of Congo is the world’s biggest producer of cobalt, for example, where the industry also includes child workers. That doesn’t seem compliant with the S and G in ESG whatsoever.
Tesla announced last year it would ditch cobalt in its battery production, a plus on the social and governance side that would also reduce their cost.
Problem 4: Making money
Another trade-off is performance.
Funds aimed at sub-genres of ESG, such as BlackRock’s (BLK) iShares Global Clean Energy ETF (ICLN) or the Invesco Solar ETF (TAN), just haven’t done very well this year after soaring in 2020. Both ETFs are down some 20% for the year, while the S&P 500 (SPX) by contrast has gained nearly the same percentage.
So for ESG-conscious investors who want to see a handsome return, the broader funds might still be the best way to go.
ESG investing doesn’t do away with all problems in business, environmental or otherwise. But investor decisions still make a difference.
“As investors we have to invest in the future we want to see,” Levy said.
That means understanding the depth of the commitment companies are making to reach their ESG goals and how they can actually be held accountable.
“That’s one of the reasons ESG investors such as ourselves are pressuring the SEC to require climate disclosures,” which would standardize that kind of reporting, Levy added.
Shareholder activism surrounding ESG issues is also becoming more common.
“Companies are starting to realize that they have a fairly sizable amount of ESG-minded investors in their investor base,” said Hale, the Sustainalytics sustainability research director. And that’s “doing some good in terms of shifting corporate behavior toward operating with sustainability in mind.”
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