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The team at Osmosis Investment Management ask whether cigarettes, which kill more than eight million people a year, be deemed a more responsible investment than electric cars
ELON Musk is never far from the news and neither for that matter is ESG (environmental, social and governance), the responsible investment approach that has taken the investment world by storm in recent years.
Both were back in the headlines this month in response to a report released by S&P Global which gave Tesla, arguably the poster child for the green transition, a significantly lower ESG score than tobacco manufacturer Phillip Morris.
‘ESG is the devil,’ was Elon Musk’s response to the report that Tesla received only 37 out of a maximum of 100 points, versus the 84 achieved by the manufacturer of Marlboro cigarettes. On the face of it, it is difficult to argue with Musk. Electric vehicles promote a cleaner environment, while cigarettes can kill you. Incidentally, the same data provider also scores Tesla lower than oil major Shell.
The S&P Global rating is not an outlier, however. Big Tobacco has outshone Tesla in the ESG ratings before. Sustainalytics, another widely used ESG ratings tool, also gave Tesla a worse score than Altria, one of the largest tobacco producers in the world. And not long ago the London Stock Exchange hit the headlines when it gave British American Tobacco an ESG score of 94 – the third highest of any company on the exchange’s top share index.
But what is behind these scores and are we to trust the assessment? Third-party ESG data ratings have come under heavy scrutiny in recent years, so with the help of Osmosis Investment Management, a quantitative environmental investment manager with its own in-house research team, we look at some of the issues with ESG scores.
E, S and G cover a wide-ranging set of distinct challenge
ESG rating agencies use hundreds of indicators to measure a firm’s performance on the numerous diverse concepts within each category – carbon emissions, water usage and generated waste in the E, workplace safety and human rights in the S, and board independence and executive compensation in the G, to name a few.
Tesla’s ‘medium’ score of 37 was the amalgamation of its environmental, social and governance ratings, which were 60, 20 and 34 respectively. Tesla clearly fell short on the social and governance side, a likely fallout from its poor labour practices and well-documented cracks in its governance, such as key person risk. Philip Morris, on the other hand, achieved a social score of 84 in S&P Global’s ratings. The company would have scored points for its extensive diversity programs and its ambitious goals to become a majority-smoke-free business over the next two years.
Osmosis Investment Management has long argued that addressing the concerns within E, S and G simultaneously is an inherently difficult, if not impossible, task. The issue, it says, is even more evident when operating within the confines of a well-diversified and risk-controlled investment portfolio.
Materiality
The importance given to each ESG category will often depend on the agency rating them. Rating providers will put different importance on E, S and G categories, making it difficult to objectively compare scores and companies. One company may be rated as best in class by one provider and worst in class by another.
Depending on what is deemed to be material, tobacco stocks can score highly on sustainability, as much of the analysis focuses on the company itself and not on the long-term sustainability of its products.
Data quality and standardisation
Perhaps the most documented challenge faced by ESG investors is the availability and reliability of ESG data.
The data required to analyse a company’s ESG performance is not standardised across industries and regions and there is no universal standard from which companies need to report. The use of estimations is rife and disclosure levels are variable. It is possible that Tesla has been penalised for a relative lack of transparency when compared to Philip Morris. The company has historically poor disclosure rates which lie in direct contrast with the tobacco manufacturer that has put disclosure at the top of its agenda.
This lack of consistency makes it difficult to compare and benchmark companies effectively, which can result in strange outcomes. Osmosis’ research emphasises the importance of rating companies on a sector-relative basis. The sustainable investment firm has been standardising publicly available corporate environmental data to sector-specific frameworks since it launched in 2009. While the firm excludes tobacco from all its portfolios from an ethical standpoint, it would be misleading, it says, to compare the ESG score of a tobacco company with anything other than another tobacco company.
In S&P Global’s defence of its Philip Morris rating, it too pointed out that the rating was more useful when compared to other tobacco companies.
Greenwashing
Greenwashing refers to the practice of making false or exaggerated claims about a company’s environmental or social performance. ESG-scoring heavily relies on self-reported data from companies and greenwashing has been a frequent challenge for the industry. Without robust verification mechanisms, the accuracy and reliability of ESG scores are easily compromised and it becomes challenging for ESG investors to differentiate genuine sustainability efforts from marketing tactics.
Critics of Big Tobacco argue that ESG reporting has provided companies like Philip Morris an opportunity to distract the world from the harm they cause and direct their attention instead to its efforts to reduce child labour and its investments in ‘reduced risk’ and nicotine-free products.
There is no single source of ESG truth
Is Phillip Morris more sustainable than Tesla? The fact is that to compare these companies on a like-for-like basis is nigh on impossible, and relying on subjective aggregated ESG scores will not provide the answer.
The high reliance of investment managers on third-party ESG scores is both surprising and disconcerting given that correlations are low, data transparency is poor and many data points are generated by qualitative and subjective means. Osmosis Investment Management argues that to drive the global transition to a sustainable and just future, the industry needs to depart from the aggregate ESG approach, and that only a more focused, evidence-based approach will truly distinguish those who walk the walk from those who merely talk the talk.
For more information visit osmosisim.com and osmosisim.com/esg-so-far-a-triumph-ofform-over-substance.
