Ethical Snake Oil

comparison of ESG scores by MSCI & FTSE

Environmental, social and governance investing, also known as ESG is a common way for investors to look to add ethics to their portfolio. A recent CLSA report highlights that ESG ratings are more akin to snake oil than medicine. The ESG ratings might not do you too much harm, but don’t mistake them for medicine.

By way of background, there are a number of fund managers running ethical funds with an investment process of:

  1. Take a feed from a data provider to work out what stocks are allowed/not allowed 
  2. Try to buy the best stocks they can find in that limited universe

i.e. the fund manager basically outsources the ethical part of the job and focusses on the stock picking.

The problem is there are a number of different providers out there who sell ESG rating scores, and CSLA just put out a report showing how the ESG scores from two different researchers (FTSE and MSCI) compare:



Key comment from the report:

We believe that these studies do not discredit ESG data or the practice of scoring

I beg to differ.

The chart above clearly shows there is little relationship between the two, i.e. there are lots of pristine ethical stocks by one methodology that are pariahs under the other methodology and vice versa. Tesla was a stock CLSA highlighted as:

  • Last for global auto ESG according to FTSE
  • Best for global auto ESG according to MSCI
  • About average according to Sustainalytics.

Having spent a lifetime with quantitative scoring systems I can tell you that most of them have significant problems as soon as you start trying to combine different measurements – for example Alphabet (Google) has a broadly diverse and independent board (good governance) but a shareholder structure that gives some shareholders more votes than others (bad governance). Which is more important? How can you combine those into a meaningful score? 

Add to that the problem of measurement. Measuring something like board diversity is difficult enough, but reading about how a company rates on “social” impact can sometimes seem to have the same intellectual rigour you would expect to find in your horoscope.

Then you get to the ethical side. Some people think tobacco is horribly addictive and unethical but gambling is each person’s own choice. Others have exactly the opposite view. Some people are happy to own Boeing as most of its business is from passenger aircraft, others don’t want any company involved in warfare (Boeing supply planes to the US military).

Rather than letting an ESG ratings company make these choices, I prefer to let investors make the ethical decisions – I’ll knock Boeing out of the portfolio for some investors but keep it in for other investors. 

For governance scores, I prefer to use them as a negative screen rather than a positive one. i.e. bad governance can make a quality score worse (and therefore the company needs to be cheaper before I buy it), but I’m not deciding to buy the company with 42% gender diversity over the one with 35%. Many of the governance scores are like that – there is a clear “bad” option, but there is little sense trying to rate the difference between two good options. 


Some of my tips for ethical investing from a prior post:

If there is a cause you are passionate about and you want to support companies in that area, there are four ways you can support that cause, in order of most helpful to least helpful:

  1. Make a donation. Are you trying to help or are you trying to make money? If it is the first then by donating you can feel good straight away, you get a tax deduction up front (rather than waiting to book a capital loss when you sell shares!).  Donating directly to companies is not generally tax deductible – but I’m guessing if your cause is ethical then there will be industry bodies that are tax deductible.
  2. Buy the product yourself. Most companies want more customers rather than more shareholders – and the ones that don’t you shouldn’t be investing in.
  3. Buy shares from the company in a capital raising. That way your money will actually go to funding the company expand or its research and development.
  4. Buy shares on the market. This is the least helpful way of helping the company. All you have done is transferred money to another investor. 

Final word

  • If you want to make the world a better place using your money, consider other ways first – would a donation be more helpful?

  • If you want to ensure your investments don’t make the world worse, then find a product that avoids stocks that align with your values or use one like the Nucleus fund that allows you to customise your ethical choices.

  • If you are buying free-range eggs, fair trade coffee or ticking the box for green energy, you don’t expect a discount vs the alternative.  Think of ethical investing in the same way – expect to give up a little performance, and occasionally you will be pleasantly surprised when it outperforms.

  • I’m sure there are plenty of jobs that you wouldn’t do, regardless of how much more money you get paid.  Why should your investments be any different?

  • Check the fees. Please. If not for yourself then do it for me. Few things in the investment world irk me more than seeing ethical funds sold for unethical fees