In a show of force reminiscent of the US invasion of Grenada, 50 German police officers raided fund manager DWS in Frankfurt earlier this year. The overwhelming size of the operation had its intended result as the doomsday scenario of officers breaching the office under a cascade of projectiles featuring financial calculators and Bloomberg terminals failed to materialise. The search warrant was executed, and justice was served. The crime was greenwashing which is finance-speak for selling investments as “more sustainable” than they actually are. Welcome to wacky world of ESG.

You’ve probably heard a lot about ESG. For those unfamiliar with the term, I will quote the CFA Institute’s definition. ESG is “the practice of considering environmental, social, and governance (ESG) issues as part of their financial analysis to gain a fuller understanding of the companies in which they invest.”

At the surface this definition indicates that I simply need to take ESG factors into account like any other risk with an investment I make. If that is the case, I just need to make sure I’m adequately compensated for the risk of a company I invest in – let’s say a coal company. A coal company is facing a myriad of risks related to environmental factors. Yet as an investor, I’m supposed to understand that there is a share price where I’m compensated for taking on any risk. This interpretation of ESG means that I would buy a coal company at a certain price. In fact, the attractiveness of investing in a coal company would probably be enhanced at a certain point by ESG factors. If it is unlikely any additional coal mines would receive permits to operate it would certainly make existing mines more valuable.

In reality, ESG investing means taking those environmental, social and governance factors into account and then using them to exclude certain companies from the pool of investments that I’m willing to consider. For instance, more than 3,000 investment groups with over $103 trillion in assets have vowed to “integrate” ESG into their investment approach. I tried to figure out what this means and the best I can come up with is that firms should evaluate their investments to support a more “sustainable, green and inclusive” world. Those are admirable goals and something I support. The devil is in the details, however. The question we all need to ask ourselves is if the way the financial services industry is approaching ESG is good for investors and good for society.

It is beyond clear that people want to live their lives according to their values. And people are being increasingly mindful of how personal decisions impact the world. It is natural that this has extended to investing. And like good capitalists, the financial services industry has responded to this desire with a bevy of products. Investors wanted the opportunity to invest according to their own values and what they got was the opportunity to invest according to the values of fund managers and index providers. And this sudden interest in ESG by these fund managers is far from benevolent. A Morningstar report in 2020 showed that the average asset-weighted expense ratio of all US funds and ETFs was .41%. ESG funds and ETFs came in at .61%. The Australian managed fund industry held $2.5 trillion in assets in March of 2021 according to ASIC. That fee deferential would mean $5 billion in additional profits. Presumably, that buys a lot of carbon offsets on private plane travel.

The investment industry has jumped into the ESG game with both feet. The first instance of what morphed into ESG investing started in the 60s with religious groups who wanted to exclude certain industries from their portfolios that didn’t align with their values. What we have now can unironically be described as the ESG-industrial complex. Index provider MSCI has 1,500 ESG related indexes. That is a shocking number even when looked at within the context of a widespread proliferation of indexes. Unsurprisingly, this has made investing “according to your values” incredibly complex.

The driver of this multitude of indexes is the disparate definition of what ESG means and what companies meet these standards. And if you think this debate is even remotely settled you haven’t been paying enough attention. Take Tesla for example. Standard & Poors recently removed Tesla from their ESG index citing the “lack of a low-carbon strategy” and their “codes of business conduct” along with accusations of racism and poor working conditions at a factory in California. In the measured response we’ve come to expect from Elon Musk, the Tesla CEO tweeted “I am increasingly convinced that corporate ESG is the Devil Incarnate.” He went on to say that “Exxon is rated top ten best in world for environment, social & governance (ESG) by S&P 500, while Tesla didn’t make the list! ESG is a scam. It has been weaponized by phony social justice warriors.”

Perhaps the real question is if the issues we are facing as a society can be solved by the investment industry. If I am going to pay more to track a slimmed down index that adheres to ESG criteria I at least want to know if I’m doing some good. There are some thoughtful people that think the investment industry is not the body to take on this important work. One of those people is Tariq Fancy. He happens to be the former Chief Investment Officer for sustainable investing at BlackRock. To say he is dismayed by what is going on is an understatement. He wrote a long article on Medium that outline his thoughts. I won’t revisit his whole argument, but he described his role at Blackrock in the following way:

“In my role at BlackRock, I was helping to popularise an idea that the answer to a sustainable future runs through ESG and sustainability and green products, or in other words, that the answer to the market’s failure to serve the long-term public interest is, of course, more market. A bit like the NRA’s traditional answer to mass shootings and related concerns around public safety — the answer is more guns.”

He implies that the investing public has been hoodwinked by all the discussion about ESG. Referencing a survey of investors, he had the following to say:

“I suspected that every time people read the latest such headline about guarding against climate change-related risks in the financial system, they mistakenly believed that these efforts were helpful in the fight against climate change itself. In fact, the survey found that not only was that true, but that most people think that this kind of work is just as helpful as any other pledge, such as large-scale organisational commitments to become net zero carbon emitters. Unfortunately, protecting an investment portfolio from the disastrous effects of climate change is not the same thing as preventing those disastrous effects from occurring in the first place.”

In short, Tariq Fancy is saying that the German police better call in for some reinforcements. The greenwashing going on extends far further than a fund manager that embellishes their assessment of ESG factors.

Most people will simply go with the flow. In investing it is often wise to take a contrarian view. But when the contrarian view is to chose to not support a “sustainable, green and inclusive” world it becomes a little more challenging. It isn’t my job or my right to tell you if investing in Tesla is in line with your values. That is because they are your values. What I can tell you is that the approach taken by the industry follows the financial services playbook. Charge high fees, in some case misrepresent what you are selling and make something so utterly confusing that investors throw their hands in the air and just succumb to the impossibility of doing this without ‘professional’ help. Overlay all this with a clever marketing pitch extoling the self-serving and self-absolving notion that changing the world requires little personal sacrifice and you have the state of ESG investing today. I for one have chosen to ignore the ESG mania, choosing the ballot box and my personal choices as the way to express my values.

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