How green is my index?

Claire Smith, Beyond Investing

Beyond Investing’s Claire Smith (pictured), creator of the US Vegan Climate Index writes this week’s In My Opinion, asking ‘Are all ESG Indexes as green as you want them to be?’

When Laurence Fink, chief executive of BlackRock, with nearly USD7 trillion under management, vows to put sustainability at the core of the firm's new investment approach, markets and investors sit up and listen.

But a swift analysis of the current lexicon used in so-called ‘climate-friendly’ investments is at best evasive, at worst simply greenwashing.

Without naming names, let’s briefly analyse a few of the biggest environmental, social and governance (ESG) and fossil fuel-free indexes. 

One leading index adjusts its composition to avoid companies that are “fossil fuel free”, which is defined as companies that do not own fossil fuel reserves. The immediate issue here is that while these companies might not ‘own’ fossil fuel reserves, they can clearly be allowed in the index even if they are dealing in energy. So, while oil companies might be excluded, electric utility companies, as an example, can be included, as technically they do not hold reserves. 

Another index is described as being composed of 250 companies with high ESG factor scores as calculated by a leading US-headquartered multi-asset portfolio analysis firm. 

This firm’s ESG calculations are not based on immediate, obvious environmental footprints, but rather a set of broad questions which analyse what the most significant ESG risks – and opportunities – face a company and its sector, the company’s exposure to these identified risks, and how well it is managing those risks and opportunities. 

Put simply, those high ESG factor scores could mean that a company is aware of its environmental impacts and is making some attempt to deal with them – but it does not mean it is a prima facie environmentally sound operation. 

Fossil-free indexes that take account of social issues, like gender diversity, may come up short on their constituents’ waste and water footprints. An index that applies scores based on business behaviour may still contain companies in sectors such as energy where their entire business model comes into question.  ESG indexes constructed by major asset managers tend to operate more from socially responsible principles, excluding so-called ‘sin stocks’ like alcohol, tobacco and gambling, as opposed to having a strong environmental focus.

So while Fink has written to clients suggesting BlackRock plans to sell off stakes in companies that derive more than 25 per cent of their revenues from thermal coal production from its actively managed client portfolios by mid-2020, the jury is out among more climate change conscious groups, who suggest the world’s largest financial institution needs to back up its claims. Moreover, there is no apparent change planned within its passive funds, a far larger part of its business, which track standard non-ESG market indexes. 

News agency Reuters reports that Blackrock, alongside State Street and Vanguard, still cast critical proxy votes in favour of the fossil fuel dominated status quo. A recent Guardian newspaper report reveals that Blackrock currently has 3.27 billion barrels of oil, 1.35 billion tons of coal and 21.7 trillion cubic feet of gas reserves under management. Its fossil fuel portfolio is valued at USD87.3 billion in listed funds. 

According to the article, the big three’s effective thermal coal, oil and gas reserve holdings through the companies they manage have surged by 34.8 per cent since 2016. They are now the world’s largest investors in public oil, gas and coal companies.
 
Even the Church of England is testing the water in terms of eco-friendly investment – already proving to be something of a misnomer, given that its recently announced ‘eco index’ includes oil majors, as long as the fund managers believe those majors are working to curb their carbon-dioxide emissions in line with the targets of the 2015 Paris agreement.

Part of the problem is that the major financial institutions move slowly, and face a backlash from the pro-fossil fuel, climate change-denying community. There are deeply entrenched attitudes and investment strategies that will take many years to unshackle.

This is the landscape that the US Vegan Climate Index (VEGAN) aims to address.

Having run the major ESG and fossil fuel-free indexes, including those cited above, through the Impact Cubed impact measurement system, Beyond Investing, creators of VEGAN, can confidently report its real impact in terms of a reduced carbon, waste and water footprint, which is significantly more material than those leading competitors.

VEGAN’s metrics on these three important characteristics are considerably better than all the major benchmark ‘eco-friendly’ indexes. What makes VEGAN truly impactful in its lack of negative impacts is an appreciation that excluding fossil fuel is simply not enough.
 
In its construction of VEGAN, Beyond Investing examines the 500 largest US stocks and excludes companies engaged in fossil fuel extraction and production of energy, animal harm and exploitation, military and defence, human rights abuses and other environmentally damaging activities. By also paying heed to the UN’s Sustainable Development Goals (SDGs) VEGAN provides possibly the most complete climate, water and biodiversity friendly solution for environmentally concerned investors.

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