Terence Corcoran: There is no science in ESG investing

Junk Science Week: Nothing could be further from being solid and measurable than the current ESG movement

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Welcome to FP Comment’s 23nd annual Junk Science Week, guided by our standard definition: Junk science occurs when scientific facts are distorted, risk is exaggerated and the science adapted and warped by politics and ideology to serve another agenda.

In the investing world, science is generally hard to find, although a debate has raged for many years over a classic question: “Is investing an art or a science?” The general conclusion is a waffling statement: “Both.”

Or it might be a crap shoot. For years the Wall Street Journal ran a contest that pitted investment pros against a dartboard. After 14 years, the pros turned in an average 10.2 per cent investment gain, the darts just 3.5 per cent, and the Dow industrials 5.6 per cent. So the darts are out, leaving the science and the art.

The new ESG investment model raises a new question: “Is investing an art or science — or politics?

Today, however, the art + science consensus may need to be replaced with the arrival of ESG investing and the incorporation of environmental, social and governance principles into investment decision-making. The new ESG investment model raises a new question: “Is investing an art or science — or politics?”


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ESG has clear political origins. The term ESG was launched in a 2004 report titled “Who Cares Wins” from a United Nation’s operation called the Global Compact Initiative. It was set up by former UN secretary-general Kofi Annan. The ESG report was in turn based on the work of Klaus Schwab’s World Economic Forum and its Global Corporate Citizenship initiative.

Enthusiasm for the idea that corporations are citizens with rule-making powers beyond making money for shareholders — known as stakeholderism — has morphed into a global ESG investment movement, with trillions of dollars flowing through global markets in search of ESG magic. Because it is a political movement, however, ESG has emerged as a wildly unscientific agglomeration of investment models that have no consistent basis in fact or data, no measurement systems, no objective standards, no consistent rating systems and no clear accounting standards.

Global accounting giants, investment houses, regulators and standard-setting agencies are scrambling to figure out what ESG and sustainable investing means, even as they launch massive ESG marketing campaigns and promotional announcements — and even though there are no accounting or investment standards. One of the big accounting firms — EY — claims ESG standards (once developed) “will empower companies, providing objective data that reinforces the value of the work being done to build an organization’s long-term value and sustainability. Within a short period of time, it’s likely that ESG metrics will become an expected part of a company’s financial reporting and an essential tool in measuring a company’s worth today, tomorrow and in the future.”


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The International Financial Reporting Standards Foundation, which oversees international accounting standards, is now trying to come up with a plan to measure and track climate and green standards, probably with a separate international green accounting board. It hopes to have some kind of rough technical guide before the big COP26 climate conference in November.

In the investment field, meanwhile, there is mass confusion over ESG ratings and measurements. What makes a good clean ESG corporate investment? Ratings agencies abound, but none are consistent in their results. The ESG measurement crisis has been building for some time, confusing investors and corporations unable to bridge the underlying problem: ESG concepts are unmeasurable. How do you measure corporate gender policies, carbon emissions, community involvement, environmental management, or worker satisfaction? As one investment consultant once said about the ratings confusion: “ESG analysis, by its very definition, is subjective.”

In other words, there is no science in ESG investing. The scale of the subjectivity was demonstrated in a recent paper — Inside the ESG Ratings — by a team of European researchers for the Leibniz Institute in Frankfurt headed by Monica Billio, a professor of economics in Venice.


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Their findings include the fact that — unlike the credit rating systems, which are said to be 99 per cent consistent — there are competing definitions of ESG criteria and inconsistencies in corporate reporting of ESG information, much of which is non-quantifiable. The paper examined nine rating agencies — including MSCI, Sustainalytics and Bloomberg — and found that they compound the reporting problems by adopting hundreds of rating assessment parameters which differ from agency to agency.

Results can be confounding. Example: Nissan Motors and Verizon Communications were each assigned different and contradictory ratings by the agencies. Nissan was ranked low by two rating agencies and best-in-class by two others. Verizon was also rated erratically. The Billio paper comments that “currently applied metrics can lead to contradictory evaluations” and that there exists “a strong evaluation disagreement among” the rating agencies.

In FP Comment’s Junk Science Week manual, contradictory results and all the other murky aspects of ESG suggest a lack of science and the prevalence of something else: politics, ideology and another agenda.

Nothing could be further from being solid and measurable than the current ESG movement or, as it should be known, Extra Sensory Governance. We can’t measure it, but it’s there. We can feel it.


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