Interesting read. Its criticism is applicable to the screening part of the process and some other naive approach to SRI investing.
More rational approaches exists.
One I studied on my free time is centered on ESG risks (see my other post). This is the one MSCI takes, at least for some of their indices.
The short version: Investors should invest on the efficiency frontier, meaning they should only be exposed to compensated risk. Typically investors use past volatility as an example of compensated risk. Lack of diversification is an example of an uncompensated risk.
Providers of ESG ratings effectively argue that:
- Many ESG risks are uncompensated.
I believe that to be true. If for example the company accountants doctored the books, then the share prices won’t reflect that. Same thing if IT hid a data leak (example: Equifax). - ESG-based ETFs increase the discoverability of ESG risks, meaning companies must compensate investors to maintain their exposure (or more likely, reduce their exposure).
That’s probably somewhat true, through the mandates that most ESG ETFs have as well as the economic incentives for index providers (example: BlackRock engaging with the HK stock exchange for more transparency). - ESG ratings captures enough of the uncompensated ESG risk to make up for increased fees of the corresponding ETFs
That’s the crux of the issue. If it’s true then ESG ratings are a quality factor and will remain so until enough companies have plans to properly manage their ESG risks (at which point ratings will be reflected in price and useless). If it’s false then it’s a cost that’s to put in the balance against increased discoverability of issues. I personally expect that the cost of the ETFs and risks of the methodology roughly cancel the benefits of reduced risk (which means that ETF providers priced it correctly) but preserves the benefit of discoverability for society.
I would be very curious of hearing of other rational approaches to SRI investing.