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Missing The 'G'

Despite ESG standing for Environmental, Social, and Governance, people tend to focus on just the E. So when a company like Tesla is removed for S and G reasons, investors are left confused and frustrated.

ESG investing standards have been in the news a lot lately following Elon Musk’s Twitter rampage after Tesla was excluded from S&P 500’s ESG index. It comes as interest in ESG investing continues to grow with US$649b invested in ESG-focused funds worldwide between 1 Jan 2021 through 30 Nov 2021.

Before we continue, let’s define ESG investing. ESG stands for Environmental, Social, and Governance and is simply a type of index investing that uses an internally created ranking to determine a company’s eligibility instead of market capitalisation. This type of investing is better known as ESG investing using a smart beta index strategy. For those not familiar with the concept, smart beta index investing simply uses a custom set of parameters, instead of just matching a market capitalisation approach like Vanguard’s S&P 500 ETF ($VOO).

Sure, E stands for environmental, but what does that actually mean in practice? The truth is that it’s not clear, and varies depending on the index’s standards. A perfect example of this is the S&P 500’s ESG fund which includes Exxon ($XOM). How is this possible? Simple, the S&P compares companies in the same industry, not the market in general.

Meantime the forgotten sibling is often the G but it’s the most related to traditional financial concerns. You see, governance looks at the decision-making of a company. In other words, how well does the company’s management take into account the opinions of shareholders. The complete control of Meta by Mark Zuckerberg has led to a failure in the G category, and is one of the reasons Meta is excluded from most ESG indexes.

The moral of the story is that ESG indexes consider a lot of factors outside of the environment, and this can lead to companies being excluded from consideration. Additionally, the small details that determine how the ranking system works vary across all ESG ETFs. So like all investments, before you choose an ESG index (ex: $ESGV) be sure to do your research.

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