ESG Stocks - is it better?

ESG stocks refer to stocks of companies that have attained a certain level of compliance with ESG benchmarks, many of which can be found within these companies’ annual reports themselves – apart from external evaluation by any third-party institutions. 

Speaking of third-party institutions, it is important to note that there is no universally recognized set of lists on which companies or activities are considered ESG-compliant. What happens is that there are many institutions that set their own criteria over what degree of activities, products, and policies amount to an ESG-friendly policy.

There are many types of indexes that you can look into, each with its own set of rules and companies that falls within their list. Among these indexes are:  

• S&P 500 ESG Index
• Nasdaq-100 ESG Index
• MSCI USA Extended ESG Focus Index
• FTSE4Good Index

Note: there are many branches of indices under the indices mentioned above, each with its own focus on certain issues, be it on climate action, social betterment, or governance best practices.

There are pros and cons to using this decentralized accreditation method. On the brighter side, if a certain company fails to be listed under one accreditation method, it can try to be listed under the others. 

For example, the S&P 500 ESG Index put a precondition that to be listed under the ESG category, a company must not be involved in the tobacco production business. Thus, despite how green a tobacco company can try to be, how socially aware and active, or how transparent their governance is – they will still not be able to bear the ESG flag. However, they can still try to score ESG points through some other methods of evaluation.

The FTSE4Good US Select Index also have similar, perhaps stricter rules, where apart from tobacco, it also excludes businesses with activities such as adult entertainment, alcohol, gambling, fossil fuel and even civilian firearms (S&P 500 ESG Index only excludes controversial weapon).

Even if the company cannot be listed in these indices, it can still provide its own ESG report which investors can access and evaluate on an individual basis. 

On the other hand, the Dow Jones Sustainability Indices which is launched in 1991 tracks the performance of the top 10% in the  S&P Global Broad Market Index based on their long-term ESG criteria. This evaluation based on a set of indices is handled by S&P Dow Jones and RobecoSAM. 

This method has received criticism over its evaluation method which is claimed to enable the “greenwashing” of certain stocks. However, the issue lies within its single-value scoring mechanism, whereby a company is given a total score out of its aggregate scores in many different aspects of ESG concern.

For example, Company XYZ sucks at keeping mother nature happy, but they are extremely glorious when it comes to governance and societal concerns. Their score in terms of environmental aspect may be a bit low, but their other scores may be cosmically high, that they still manage to earn the ESG label.

So, what we’re trying to say is – some indices’ methods may suit you, and some may not. What good a decentralized evaluating mechanism provides is that you as an investor can choose which method suits your value. Of course, you’ll have to keep yourselves familiar with the different indices and their method of evaluation.

The downside of this decentralized method of evaluation is that there are no streamlined criteria over what stocks are considered ESG stocks. Thus, it can be quite confusing if you are seeking to contribute to mother nature, for example, but a certain stock may still be under the ESG label despite not having that much in terms of environmental contribution. 

Say, you’re very keen on climate change, and you seek to change the course of the world by investing your hard-earned dollars into an ESG company. While browsing, you apparently saw an energy company which claims to be ESG-approved. Now, that’s a change of course for the better, isn’t it?

As you pour your hard-earned money into the said company, only then you started to realize that this company is scraping off every last bit of mother nature’s living soul, but how? This is where the lack of a centralized evaluation mechanism sucks. They simply look for evaluation mechanisms that would make them look good!