Georgetown isn’t exactly known to leave money on the table, but its endowment is a rare exception. In 2020, the university committed to fully divesting from fossil fuels within a decade. Georgetown’s decision was hardly groundbreaking; its divestment is part of a broader embrace of ESG (environmental, social, and corporate governance) standards by Wall Street and ordinary investors. But while ESG is often hailed as a transformational movement, shifting investors’ focus from pure profit to the greater good, today’s ESG movement is an irredeemably flawed way of doing so.
Though investors have long debated businesses’ moral responsibilities, ESG only entered the popular lexicon in 2005 with a report called “Who Cares Wins.” The movement’s scope was initially fairly limited, pushing for greater consideration and disclosure of ESG-related risks. It’s since focused largely on environmental issues, inspiring varying forms of fossil fuel divestment from institutional investors who manage nearly $40 trillion in assets and from universities nationwide.
ESG now encompasses far more than a set of principles or a divestment movement; it’s become a lucrative business opportunity, spawning a range of funds that use ESG principles to determine their investments. In fact, Bloomberg estimates that ESG assets could reach $53 trillion in value by 2025 after previously growing at a 30% rate annually. Top asset managers like BlackRock and Vanguard market various ESG funds to investors, while companies like S&P and MSCI offer comprehensive ESG ratings for individual stocks.
Don’t expect those funds and ratings to adhere to consistent criteria, though. Vanguard’s U.S. ESG fund includes Tesla and Meta, both of which are conspicuously absent from the S&P 500 ESG index. While the world’s leading electric vehicle company might seem an odd choice for exclusion from an environmentally-focused index, S&P justified its move on lagging social and governance scores.
No matter the merits of Tesla’s exclusion, it demonstrates the inherent subjectivity of ESG ratings. ESG funds and ratings require companies to not only weigh factors within categories but also assign relative importance to ESG’s three distinct categories. That’s an inherently subjective process, and simplifying ESG into a single score risks stifling vital debate about which factors should take precedence over others. The varying criteria for funds and ratings underscore ESG’s critical problem: it’s an artificial concept posing as an authentic one.
That’s partly because there’s ample ambiguity on what ESG actually is. For some, ESG is just a series of criteria—Investopedia defines ESG as “a set of standards for a company’s behavior used by socially conscious investors” that accounts for each constituent category. This broad definition may be accurate, but it’s not necessarily how investors and the media understand ESG. For instance, BlackRock’s understanding of ESG as a “data toolkit” under the scope of sustainable investing suggests that the environmental aspects of ESG take precedence and contributes to a misleading perception of ESG as an objective, data-driven standard. But ESG ratings are hardly objective; subjective judgments are just as integral as data inputs.
Conceptually, there’s no reason environmental sustainability, social considerations, and governance practices should even be grouped together. These are related but fundamentally distinct concepts, sharing only a separation from standard financial metrics. And even within the broad umbrella of ESG, governance considerations don’t quite seem to fit. The environmental and social aspects of ESG at least seem to share a common purpose: bringing ethical considerations into investing. But the moral implications of a company’s working conditions and pollution far outweigh those of accounting standards and other anodyne governance criteria. ESG’s attempt to package its three concepts as an authentic whole masks crucial distinctions between them.
All these flaws—the inherent subjectivity of ESG, the concept’s ambiguity, and the divergence between its reality and public perception—risk discrediting what could be an impactful movement. At its core, ESG prioritizes transparency, which helps investors make informed decisions and align their investments with their values. It pushes businesses toward ethical practices, rewarding high standards and holding companies accountable for abandoning basic decency. But despite these laudable aims, ESG remains an innately flawed concept, and its flaws have attracted harsh blowback.
ESG’s critics frequently cast it as a mere front for a liberal political agenda. Upon Tesla’s removal from the S&P 500 ESG index, Elon Musk complained that ESG “has been weaponized by phony social justice warriors.” The Wall Street Journal’s Editorial Board recently decried “politicized credit scores” based on ESG criteria. Yet the validity of these complaints is entirely immaterial because of ESG’s conceptual failures. Even in the absence of overt political agendas, ESG ratings and funds will inevitably seem biased—because they are. No process that requires weighing entirely different categories can ever be bias-free. But that doesn’t mean we can afford to dismiss criticism of ESG, because its growing status as a political football could generate backlash to even its most basic ethical goals. ESG is a mortal threat to itself.
Scrapping the concept of “ESG” and instead focusing on its components individually can better serve investors who want greater ethics and transparency in business. Companies that offer broad ESG funds should abandon them for issue-specific funds that focus independently on environmental, social, or governance practices. Some asset managers already offer products like this; funds like BlackRock’s Global Clean Energy ETF represent the direction that ESG needs to take. Issue-specific funds allow investors to determine what factors are most important to them and invest accordingly without relying on oversimplified ESG scores. ESG may not empower investors, but breaking up the concept can.
Similarly, companies should resist the temptation to offer composite ESG ratings and instead offer individual environmental, social, and governance ratings. ESG was meant to provide greater transparency for investors, but composite ESG scores only provide obfuscation and confusion. They add nothing that category-specific scores don’t already provide. MSCI’s ESG ratings already have scores for each category, so abandoning composite ESG scores wouldn’t even require much change. It would, however, shift investor attention back where it belongs: on ESG’s individual components.
ESG represents a fundamental shift in investing, but its conceptual flaws threaten to undermine that shift. As investors increasingly consider ethical factors, an ESG movement saddled with perceptions of bias could discredit the very goals it seeks to promote. That’s why it’s critical for ESG’s proponents to understand the concept’s flaws and leave it behind. This doesn’t require us to abandon ESG’s aims of making businesses more transparent and ethical, but we should focus on ESG’s components rather than a single, simplified ESG standard. For ESG to succeed, it needs to die.
insightful analysis