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Expect less, exclude more: Stern issues ESG warning  

Environmental, social and governance (ESG) funds should forget fiduciary duty, dump ratings and adopt extreme exclusions in a radical revamp of the investment overlay proposed in a US academic paper.

In a scathing take on the current ESG market, New York University (NYU) Stern Center for Business and Human Rights senior program manager, Michael Goldhaber, calls for a reincarnation of the original ethical investing goal where values trump value. To begin with, investors need to ditch the “fallacy” that ESG funds will deliver better returns than standard market-centric strategies.

“Return-maximizing ESG funds are based on a fiction, and therefore do little to protect the environment or society,” Goldhaber says in the report, arguing investors must be prepared to forgo returns to mollify their values.

“… To address the field’s most elemental conceptual error demands a wholly new approach. We propose that motivated ESG investors expressly authorize their advisers to prioritize specified ethical objectives over financial return. Although fiduciary law would foreclose this path to pension investors, other investors are free to choose their own investment strategies, and to loosen their advi­sors’ fiduciary duties by agreement.”

  • The report also pours acid on the multiple commercial ESG ratings that underpin many investment strategies with contrary and “confusing” results.

    “In sum, ESG raters unreliably measure wrong and inconsistent secret crite­ria in pursuit of wrong and confusing goals, handing out unreasonably high grades, and yielding random ratings that bear little resemblance to reality. The outpouring of critical scholarship should hardly surprise ESG profession­als, as the many flaws of ESG ratings are common knowledge among their users,” the study says.

    “ESG ratings are so problem-plagued that the best solution may be to stop using them.”

    Instead of using unreliable metrics to modify traditional, risk-managed diversified strategies, Goldhaber says fund managers should freely slash-and-burn portfolios to meet ‘ethical’ standards.

    “… investment managers need to install broader exclu­sions, narrower targets, and customized goals,” he says. “Because ESG funds are rife with holdings that offend ESG values, fund managers should apply more aggressive negative screens.”

    And instead of creating pooled products, often in passive format, rife with a “bundle of contradictions”, Goldhaber suggests managers must build bespoke portfolios that “fit each of their client’s values”.

    The ‘Making ESG real: a return to values-driven investing’ study offers 12 recommendations to the investment industry and five more to the US regulator including to “crack down” on ‘greenwashing’.

    Furthermore, the report warns against mistaking PR for ESG.

    “… ESG is not a catch-all for any public-spirited activity of which a company is proud. However praiseworthy, charity and volunteer work have nothing to do with sustainable reporting, rating, or investing.

    “Second, ESG is not code for CEOs taking stands on hot-button issues. In reality, no firm earns ESG ratings points when its CEO sounds off on a social or environmental controversy.”

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