On January 30, Pensions & Investments reported that a New Hampshire House committee unanimously opposed the proposed bill to make it a felony to knowingly use ESG criteria in investing taxpayer dollars. The formal vote on the bill will happen in mid-February. This felony proposal is reasonable or ridiculous, depending on your political views. However, it does call attention to an important issue about sustainable investing analysis.
The proposed legislation assumes that ESG investment criteria are clear enough that an investment manager can be liable for focusing on them. You could accuse an active manager of paying too much attention to the stock of a company based on ESG features. However, more money is invested passively than actively, typically with ETFs and financial index products. Can you accuse a passive investment manager of using ESG criteria for an ETF or index investment? How would you know? If the New Hampshire legislation passes, can you be a passive ESG criminal?
The more general and helpful question is, how do you meaningfully rate ETFs or stock indices on ESG to compare them? The rating is straightforward and revealing. Each stock in an ETF or index has an ESG score and a capitalization weight in an ETF or an index. A simple measure of the ESG score for the ETF or index is the cap-weighted aggregate ESG score of the stocks. The aggregate score is the rating. To illustrate, I used consensus ESG scores from OWL ESG, Inc. to produce the chart here to compare three ETFs.
Take the S&P500 as a reference for ESG rating and compare it to ESGU, the most popular ESG-focused ETF. The blue line in the chart shows the difference over the past five years between the ESG scores of ESGU and SPY (in yellow, set to zero as reference). As you would expect, ESGU generally has a better ESG score – though SPY was briefly better in 2020 after the Covid market crash. The chart also shows the difference between the ESG score of SPYG, the S&P500 growth index ETF (in red), and SPY. SPYG has scored better than SPY since late 2019 and has even scored better than ESGU since the beginning of 2023.
An investment manager who invested in the growth stock ETF, SPYG, before late 2019 should be safe from accusations of ESG focus since his investment had an inferior ESG score to ESGU. But for the past year, SPYG scored higher than ESGU. Could that become a potential felony risk in New Hampshire? Probably not, but it's hard to be sure. Regardless, the more helpful takeaway is that any ETF or stock index - or any portfolio - can be easily scored on ESG as a feature for investment analysis. An ESG agnostic can ignore this, but it is available for advocates of sustainable investing to frame discussion and decisions.
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