Benoît Theunissen: ESG investments are a major trend at the moment. How do you read it?
Stuart Dunbar: ESG is becoming the challenge for the financial industry and in particular the asset management industry. My concern is that we are creating a whole industry of ratings and metrics to satisfy, to some extent, the messy demands of clients. What I mean by that is that if someone comes in and says “I want a low carbon portfolio”, it’s very easy to set up a low carbon portfolio. Just don’t go to the manufacturers or the energy-intensive industries. But this is a very small snapshot of the reality of the carbon transition.
I think ESG approaches that just take measurements rather than measure progress are actually quite dangerous, in the sense that people think that by creating investment funds that present themselves as green, environmentally and socially friendly, but in fact they do not necessarily create change.
So in your opinion, ESG is too often limited to indicators?
ESG cannot be a series of measurements. ESG is a process that must be thought of as an improvement process. It is important to consider that today is always the first step in the transition to decarbonisation. What matters is whether we will be better tomorrow, whether we will do better next week or in one year, five years and ten years? It is also important to know how we will get there. In this way, it is a process of improvement.
I think it’s very dangerous to rely only on ESG scores.
Do ESG scores not measure enough improvement?
If you are a provider of ESG scores, to do so in a thoughtful, fundamental and accurate way, you have to go through the exercise of analysing each company individually. In this case, understanding where it is today, where it will go tomorrow, how it fits into a wider, complex decarbonisation system. You need to measure progress, not a snapshot. In the evaluation world, no one really wants to do this exercise, because it is resource intensive, expensive and difficult to do.
To be clear, this is not really the fault of the ESG rating providers, but rather the result of their business model. They try to process large amounts of information and get something useful out of it at the end. But I would say that it’s impossible to get good answers from that, if you don't analyse individually the situation of each company and the changes they are or are not making. So I think it’s very dangerous to rely only on ESG scores.
In your public speeches, you also highlight the variations of the ESG concept.
If we take the environmental aspect, for example, there has been a wonderful debate about the taxonomy of the European Union. Should nuclear and gas be included? I think this debate was very useful, because it revealed that people have different levels of understanding about ESG. To give you an idea of what it means, I think the answer is different in different places. If gas is a green investment, then that’s probably true in China because gas-fired power plants are replacing coal-fired power plants there. Now, in Europe, we also want to stop using gas-fired power plants.
But we have to make progress in the meantime. And of course, if we try to switch entirely to renewables, this has an impact on sustainability. So electricity would become extremely expensive or there might be a shortage of it, which would create unemployment and all sorts of other knock-on effects. Of course, gas dependency is a very topical issue with the events in Ukraine. However, there may not be a good argument for continuing to develop gas-fired power plants in Europe, because Europe is rich enough and technologically developed enough to switch directly to renewable energies. What I mean is that even this simple example cannot reduce the question to a simple yes or no or a simple measure of production.
You can see that there are perverse results.
Based on these findings, how do you integrate ESG data into your investment research work?
Of course we buy data from Sustainalytics and MSCI. We use it more as a warning mechanism for topics we might want to investigate further for individual countries, companies or sectors. So there is nothing wrong with using ESG scores to inform a decision-making process. The problem is not so much the existence of these scores, but the use to which they are put.
For example, someone will buy data from an index provider who will use ESG scores to create a green portfolio. Then someone will come and build an ETF based on the index and you will get some very, very strange answers. There’s the example where, based on different suppliers, British American Tobacco will have a higher ESG score than Orsted [a Danish company active in renewable energy]. BMW may also score better than Tesla. So you can see that there are perverse results.
So what is missing to have a more mature ESG approach?
It is missing to know the purpose of each company. Let’s take the case of a company that is at the forefront of new ways to improve the quality of life of people with diabetes. How do you measure the improvement in a person’s quality of life by knowing what their glucose levels are? You can’t reduce it to a simple measurement. That leaves out the whole debate.
Instead, ESG specialists look at health and safety policies, employment policies, sewage treatment policies, all these things, which are very valid, but they don’t take into account at all the real impact that an individual company has in the real world on people’s daily lives. And I think that’s a missing part of the whole ESG discussion. A lot of people have a hard time taking it into account because it’s more of a commentary-based approach than a quantitative rating.
Originally published in French by and translated for Delano