S&P Dow Jones Indices’ decision this week to boot Tesla from the S&P 500 ESG Index has cast a harsh light on the role that environmental, social, and governance, or ESG ratings play in scoring companies as positive for the planet.
Investment firms use ESG ratings from companies such as MSCI (MSCI), the largest ESG rating company, and Sustainalytics, owned by Morningstar (MORN), as a guide in screening stocks for inclusion in ESG and sustainable investment portfolios and funds.
ESG ratings have been under fire this year since Russia’s invasion of Ukraine. Some critics have questioned why ESG-labeled funds owned companies such as Russia’s state-backed energy giant, Gazprom (GAZP).
This week, S&P Global’s (SPGI) S&P Dow Jones Indices division said that Tesla (TSLA), which CEO Elon Musk says he founded to put the world on a path to a sustainable-energy future, doesn’t have a comprehensive low-carbon strategy and no longer qualifies for inclusion in the S&P 500 ESG Index (SPXESUP).
Tesla was “ineligible for index inclusion due to its low S&P DJI ESG Score,” Margaret Dornhead of ESG Indices, North America, at S&P Dow Jones Indices, wrote in a blog post explaining the decision. “So, while Tesla’s S&P DJI ESG score has remained fairly stable year-over-year, it was pushed further down the ranks relative to its global industry group peers.”
John Streur, president and CEO of Calvert Research and Management and president of the Calvert funds, says there is “nothing about what we heard from S&P that would change our mind about Tesla.”
Calvert, a pioneer and leader in responsible investing since 1982, with $37.2 billion under management as of March 30, owns Tesla stock in several of its indexes and funds, including the Calvert US Large-Cap Core Responsible Index Fund (CISIX) and Calvert Global Energy Solutions Fund (CAEIX).
“We look at Tesla and we see what an important impact they have in an important sector in terms of reining in climate change, reining in carbon emissions,” Streur says. “We’re holding the [stock] in the context of a company with enormously ambitious plans, that is rapidly scaling on a global basis. And we are pushing them and engaging with them to continuously improve how they treat their employees and their environmental sustainability.”
Aniket Shah, global head of ESG and sustainable finance strategy at Jefferies, says the ESG community should consider S&P’s decision to remove Tesla from the index “a true indictment” of ESG ratings.
“ESG ratings aren’t a helpful way to do ESG analysis,” says Shah. “It is not possible, nor is it worthwhile, to try to boil down the complexities of ESG issues to a single score or a single letter.”
An S&P Dow Jones Indices referred spokesperson Barron’s to the company’s blog post but declined to comment further.
Those who expect ESG ratings to be a reflection of a company’s planetary impact are going to be “sorely disappointed”, says Ken Pucker, a senior lecturer at The Fletcher School at Tufts University. “The problem is that many people think an ESG rating says something about a company’s social sustainability or planetary impact, when that isn’t what it is,” he says. “The fact that Tesla gets rated either high or low on ESG says nothing about Tesla’s transformational impact on the auto market.”
With many firms offering ESG scores, it can be challenging for investors to differentiate among them. For example, Sustainalytics assigns Tesla a rating of 28.5, which indicates the company has medium risk, according to Sustainalytics’ ESG Risk Rating scoring system. Sustainlytics’ system measures a company’s exposure to, and management of material ESG risks.
Sustainalytics also evaluates the company using “impact metric,” such as human development and resource scarcity, that are based on the UN Sustainable Development Goals (SDGs).
According to MSCI’s ESG Ratings and Climate Search ToolTesla has an “A” rating, and is considered average among 41 companies in the automobiles industry.
It has been a tough year for ESG fund sponsors and investors due to lagging performance and declining investment flows into ESG investing strategies. ESG ratings firms have also faced tough questions over Russia.
In April, the state of Utah wrote a letter objecting to S&P Global Ratings publishing ESG credit indicators as part of its credit ratings for states and state subdivisions. “S&P gave Russian-controlled energy producers higher ESG ratings than similar entities in the US Russian energy giants Gazprom and Rosneft
outscored American energy companies Exxon Mobil and Chevron on S&P’s ESG scale,” it stated.
Amber Fairbanks, portfolio manager at Mirova, the sustainable investing affiliate of Natixis Investment Managers, says she understands how people can be critical of ESG after seeing the news about Tesla, as “it just doesn’t make a lot of sense.”
While Tesla was cut from the index, Exxon Mobil (XOM) was added this year, raising some eyebrows.
“We’ve always seen some problems with third-party rating agencies, particularly their reliance on disclosure,” says Fairbanks. “It’s why a company such as Exxon Mobil is rated quite highly. They have a tremendous amount of disclosure around sustainability.”
Aswath Damodaran, a professor of finance at the Stern School of Business at New York University, has a different view regarding Exxon Mobil’s inclusion. “The good news is that fossil-fuel companies aren’t destined to always be viewed as bad companies, no matter what they do,” he says.
Write to Lauren Foster at [email protected]
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