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ESG: Sham or not?

By Joshua Ong:

With the increased frequency of economic, health and social issues showing up in the media, interest from investors and corporate stakeholders in “ESG” is at an all-time high. ESG stands for “environmental, social and governance”, which essentially stands for the ways a company can be evaluated with respect to a range of socially desirable ends. ESG describes a set of factors used to measure the non-financial impacts of companies and investments, and companies with better ESG ratings often are seen as more socially responsible and sustainable, well-governed and diverse.

According to a Harvard study, in 2021, the estimated value of assets under management in ESG funds was around $330 billion, with more expected in 2022. In 2021, the assets under the management of investment firms that signed the United National Principles for Responsible Investment (UN PRI) reached $103 trillion. The UN PRI is a United-Nations-supported international network of investors working together to implement its ESG-focused principles. There is definitely a growing awareness among investors, consumers and companies to consider their impact on other non-financial metrics. Recently, the S&P500 rated Exxon as top ten in the world for ESG, whilst Tesla, arguably an ESG-focused maker of electric cars, did not even make the list. The question then is: How is ESG measured? Does this shift actually benefit us as a whole?

Rise of ESG Activism

ESG activism levels have increased considerably in the past two years. Some proposals by activists include calls for reductions of Scope 3 greenhouse gas emissions and greater gender, racial and ethnic diversity on boards. There has also been increased activist pressure against “Big Oil”, such as Exxon Mobil and Shell, pushing for a more aggressive reduction of emissions and nudging companies to implement changes to improve gender parity and inclusiveness on their boards. The investment industry expects ESG activism to target “Big Tech” next, on issues related to fossil fuels and other ESG concerns. Although these technology companies have had a more progressive stance towards LGBTQ+ rights and sustainability, there have been rising concerns regarding data privacy and surveillance.

ESG in Asia

In 2012, there was essentially no market for sustainable investing in Asia, compared to Europe where it was relatively more developed. In Asia, a combination of regulations and investor pressures caused Asia to gain pace in its progress in ESG and sustainability. Regulatory developments include stewardship costs, ESG risk management guidelines, forming of steering committees and cross-collaborations among industry players. Additionally, pressure from international investors in the EU and US who have been increasing allocations to ESG assets has exerted influence in pushing for a greater focus on ESG in Asia. The Economic Intelligence Unit found that there has been a “significant change in the awareness, uptake and impact of ESG in Asia over the past three to five years”.

In China, the Chinese Party’s new five-year plan from 2021 to 2025 focuses on sustainable development. The Asset Management Association of China (AMAC) issued China’s first systematic and comprehensive voluntary standard for China’s AM industry which includes guides to green investing. China has also introduced the Green Investment Principles for the Belt and Road to embed principles of sustainable development in the new Belt and Road investment projects in 2018. In Hong Kong, the Securities and Futures Commission (SFC) released a list of verified ESG funds in 2020 to combat greenwashing, as well as launched the Green and Sustainable Finance Cross-Agency Steering Group (Steering Group) to coordinate the management of climate and environmental risks to the financial sector. In Southeast Asia, the Monetary Authority of Singapore released a paper on “Environment Risk Management Guidelines for Asset Managers”, and started a Sustainable Bond Grant Scheme to encourage sustainable development.

How ESG is measured

Generally, ESG metrics are processed and weighted by companies that produce ESG ratings, to generate ESG scores. These companies, like Refinitiv, S&P Global, Sustainalytics and MSCI, use their proprietary methods to process data of different metrics collected for thousands of companies to generate ESG scores for each one. For example, Refinitiv has over 700 researchers to collect ESG data and over 630 ESG metrics that are processed manually for each company, for the information to be standardised and ensure its comparability. Prominent examples of metrics would be greenhouse gas emissions under the environmental column, workforce diversity and inclusion policies under social, and finally, business ethics and anti-corruption management would fall under governance.

Figure 1: Refinitiv’s ESG data collection method

Figure 2: Examples of metrics used to measure ESG by Refinitiv

Arguably, ESG is a subjective topic that, although can be somewhat condensed into ones and zeroes, cannot be fully distilled into one quantitative metric. Not only does the exact methodology behind the metrics differ depending on the company issuing the ratings, it can also be argued that the everchanging list of topics under the ‘ESG’ umbrella and the myriad of ways any company can contribute to ‘ESG’ issues means that there rarely one ‘best’ way of calculating the ESG score of any company. In addition, knowing how these ESG scores are derived can lead to some companies attempting to be seen as more ESG-focused, also known as “greenwashing”.


Greenwashing can be defined as the use of marketing and PR to overamplify ESG efforts to gain greater favour from investors, consumers and employees. A high-profile case that involved police raiding Deutsche Bank and its asset management unit in Frankfurt was linked to greenwashing accusations, with claims that “hundreds of billions of its assets under management were "ESG integrated" were misleading because the label didn't translate into meaningful action by relevant fund managers”.

A more recent case is the SEC’s probe into Goldman Sachs Asset Management’s mutual-funds business on whether the investments in the funds breached ESG metrics promised in the marketing material. A study by a shareholder advocacy group also found that 60 of 94 ESG funds did not adhere to the principles of ESG investing, leading both ESG investors and regulators to exert pressure on companies to substantiate their claims with metrics.

ESG portfolios

With regards to ESG funds, ESG funds outperformed the S&P 500 in the first 12 months after the Covid-19 pandemic. S&P Global Market Intelligence analysed 26 ESG funds with more than $250 million AUM and found that in the year leading up to 5 March 2021, those funds outperformed the S&P500. However, at the start of 2022, in a turbulent investment climate, funds that incorporated ESG had it rough. Among the 170 funds with ESG mandates that focus on US equities, only 40 funds have outperformed the S&P500, and only two have generated positive returns as of February 2022.

It would be possible to rationalise that investors would sacrifice financial returns in exchange for better ESG performance. However, in the US, researchers from Columbia University and the London School of Economics compared the ESG record of 147 ESG fund portfolios against 2428 non-ESG portfolios and found out that companies in ESG portfolios had worse compliance records for labour and environmental rules. They also found that those companies did not improve compliance with those regulations subsequently. This is found to be consistent in Europe as well, as the European Corporate Governance Institute paper compared the ESG scores of companies invested in by 684 U.S. institutional investors that signed the United Nation’s Principles of Responsible Investment (PRI) and 6,481 institutional investors that did not sign the PRI during 2013–2017. They did not find any improvement in ESG scores for the companies that signed the PRI and instead found that their returns were lower and had higher risk ratings.

Why are ESG funds underperforming?

According to the Harvard Business Review, there are two main reasons for the underperformance of ESG funds. Firstly, ESG targets may distort decision-making, as corporate managers should focus on maximising shareholder value, not focus on ESG metrics. Putting too much focus on ESG and neglecting their core businesses could negatively affect shareholder value, and firms should instead pay attention to ESG interests of their own accord. The second reason would be that companies that publicly embrace ESG may be using it as a cover for poor business performance. A recent paper by Ryan Flugum of the University of Northern Iowa and Matthew Souther of the University of South Carolina showed that when managers underperformed earnings expectations, they often would shift the focus to ESG metrics, but when they outperformed earnings estimates, they made few or no statements related to ESG at all. Hence, when investors invest in companies publicly embracing ESG, they should be aware that those companies may have a higher chance of underperforming in traditional financial metrics.


So, in conclusion, was Elon Musk right in calling ESG a scam? To say that ESG is a scam simply because an eccentric tech billionaire calls it one would be an unfair statement. The ESG movement is inherently good for society and the environment, to place more emphasis on non-financial aspects that affect consumers and employees alike.

To quantify ESG is no easy task, and is one which the rating companies are striving to polish, due to its subjective nature and the fact that no two firms are identical. These companies also have to conduct very thorough analysis, as there is still much fraudulent activity in the ESG space. The focus should be on standardising ratings and ensuring that the companies’ ESG ratings are accurate and reflect the true nature of those businesses. As for ESG portfolios, investors should still be wary of companies that boast of excellent ESG ratings, and remain focused on the success of their core business operations.


Joshua Ong

Joshua is a first-year Accounting and Finance undergraduate at the London School of Economics. After finishing his national service, he interned at an asset management firm in Singapore where he conducted research on trends in the Chinese stock market, with a focus on the clampdown on the Chinese technology sector in 2021. At LSE, he is also an analyst in the M&A Group and a member of the men’s water polo team.


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