(CN) — There’s a massive disconnect between what many individual investors believe about ESG funds and what the funds actually do, which means that thousands of people who think they’re changing the world by aligning their portfolios with their values may actually be changing the world in a way they don’t like.
Investors pumped half a trillion dollars into ESG funds in 2021 alone, according to J.P. Morgan, and nearly half of U.S. retail investors, including three-quarters of people under age 40, say they prefer investing in companies that benefit the environment and society. But ESG funds — those that invest based on environmental, social and governance criteria — have no standard metrics and there are often wild divergences in how companies are rated. In other words, many of the largest ESG funds shovel money into companies that are anything but “virtuous” in the minds of their customers.
Investors concerned about climate change might be surprised that the S&P 500 ESG index includes the country’s leading producer of fossil fuels but not the leading producer of electric vehicles, for example.
The top holdings of one of the largest ESG funds, the iShares ESG Aware MSCI USA ETF, include fossil-fuel producer Exxon along with companies that have been described in the press as “the nation’s fiercest anti-union employer” (Amazon), make 90% of their products in a country with a terrible human rights record (Apple), have been harshly criticized as anti-consumer by Senators Elizabeth Warren and Bernie Sanders (JPMorgan Chase), and have been attacked by Warren as a dangerous monopoly that should be broken up (Google). The fund also invests heavily in Coke, Pepsi, Kellogg and General Mills, which produce sugary drinks and cereals that can lead to obesity and diabetes.
Another very popular ESG fund, the iShares MSCI USA ESG Select ETF, has a $20 million stake in Halliburton, which is responsible for most of the world's fracking operations.
FTX, the cryptocurrency trading platform that collapsed in November amid allegations of embezzlement by its top officials, was given a higher “leadership and governance” score than Exxon by ESG rating agency Truvalue Labs.
A shocking study by professors at Columbia University and the London School of Economics found that ESG funds overall invest in companies with worse track records of complying with labor and environmental laws than non-ESG funds, and they also invest in companies that produce a higher level of carbon emissions per unit of revenue.
Many ESG funds are simply profiting from consumer misperceptions, but some may be actively encouraging them. Last year BNY Mellon paid a $1.5 million penalty for falsely claiming that all the investments in its funds had undergone an ESG quality review, and Goldman Sachs paid $4 million to settle similar claims. German authorities recently raided the offices of Deutsche Bank looking for evidence of false advertising of ESG funds.
“Retail investors don’t understand ESG investing,” said Gerri Walsh, president of the FINRA Investor Education Foundation. The foundation conducted a survey that found that 77% of retail investors think ESG funds align with their values — but only 21% could even correctly identify what ESG stands for.
Florian Berg, an M.I.T. business school researcher who studies the industry, warned that there can be four standard deviations between how one ESG rating agency treats a company and how another one does — even as these funds "implicitly sell a change in the real world."
“So one agency thinks it’s great and another thinks it’s really bad," Berg explained.
Tobacco companies are a good example. Because they make a product that kills people, some rating agencies give them very low scores, but others focus more on their environmental impact and employment practices and give them a much more positive score.