When I first read about it I thought someone was playing an elaborate joke. It makes no sense why such ephemeral concepts should somehow lead to better investments. If anything, the entire ESG score thing seems like a scam to get people to make bad investments and to then bet against those investments.
The ideal is that companies that cause environmental damage, treat their employees and communities badly, and cheat their shareholders can be boycotted by those who don't want to fund this. Another motivation is those who think bad ESG scores are correlated with worse performance over long period of time. e.g. You think there will eventually be a carbon tax and this will hit coal companies really hard so you don't want to be the bag holder in 2050.
In practice it's just another financial product that first and foremost makes money for the sellers through higher fees. Some ESG funds cheat their customers by failing to perform the specific ESG vetting they promised in writing to do!
> It makes no sense why such ephemeral concepts should somehow lead to better investments.
Each component alone makes sense, if interpreted in a way that is consistent with shareholder capitalism.
1. Environmental. Interpreted in terms of shareholder capitalism, Environmental might mean something like "how well does this company work as a hedge against increasingly likely tail risks, and how resilient will it be to policy changes should those increasingly common tail risks result in secular or policy shifts".
E.g., a re-insurance company that is well-positioned WRT coastal flooding risk but which runs all of its offices on artisanal coal-fired powerplants -- that are a cheap and easy to replace with solar if and when needed -- should have a higher "Environmental" score than a "net zero" re-insurance company that is highly exposed to coastal flooding risk.
2. Social. Interpreted in terms of shareholder capitalism, Social should mean that middle management is not eg over-paying for labor from the Good Old Boys network instead of taking advantage of the cheapest available labor that meets quality requirements.
3. Governance. Interpreted in terms of shareholder capitalism, Governance might mean that you don't give a single founder or board member the ability to over-ride the preferences of the majority holders of equity. Also things like decisions being transparent to shareholders and so on.
The joke isn't ESG per se. The joke is that ESG as implemented makes the completely idiotic assumption that shareholder capitalism can do anything at all to solve political fissures or account for externalized costs.
1. 'Environmental' covers being net-good for the environment, neither meaning not damaging the environment at all nor meaning resilient against environmental changes. So it doesn't hedge anything.
2. 'Social' covers increasing the percentage of employees that are of disadvantaged minority groups, not decreasing the percentage of employees that are anonymously observed to be overpaid/incompetent. It's fun to pretend the one leads to the other, but in reality the exact opposite happens, as minority preference almost perfectly supplants network preference doing exactly the same thing in the same way. This one may as well be the 'G' of ESG, for 'Goodhart'.
3. 'Governance' is the only one that is actually a shareholder value, instead of a progressive-social-club value, and basically is there to launder the other two.
I think even component-wise it wouldn't work well. These components are turned into metrics that can then be gamed. They obviously are gamed: the US corporate world seems to be chock full of token efforts like this.
But if ESG did follow the points as you listed them, then it would probably receive a lot less political flak.
At least in the US, there isn't enough regulation to force companies to provide the data needed for an accurate ESG score. The scoring agencies are essentially just guesstimating based on what the companies are willing to expose. So, they're easily manipulated.
In case it wasn't obvious: the examples are firmly tounge-in-cheek.
The point is simply that markets are designed for maximizing incentives, and "ESG" as commonly defined isn't -- at least definitionally -- aligned with those incentives.
That point is pretty value neutral with respect to ESG goals; ie, believe what you want about how the world ought to be, but don't fool yourself into thinking that throwing you slogans at markets with different incentives will result in outcomes consistent with your sloganeering.
Social and governance are both factors that are going to be more political than results based. Getting a biased third party to evaluate companies on those two factors might as well be a game of darts, because what's considered actually important is going to vary based on the person's politics that's doing the evaluation (or writing the specific evaluation criteria).
Social responsibility is a nice phrase to use when you want to justify anything you want politically, but the only meaning it carries is "you should do what my politics thinks is best".
It's ephemeral because if you give those criteria to a country whose politics you don't like, then you're going to get results that you don't agree with.
