When Tesla was dropped from the S&P ESG Index, it was like a shock to the investing world (pun intended), but was not a surprise to most ESG experts. It is a reminder that while Honeytree’s team is steeped in the world of ESG, there remains a lack of awareness in the broader world of investment about construction of ESG ratings and how they are used in index creation and active investment strategies.
ESG ratings, (if you read their methodologies) evaluate how companies manage ESG risks and opportunities. The S&P ESG methodology, for example, states that its approach is an “analysis of an entity’s capacity to operate successfully in the future and is grounded in how ESG factors could affect stakeholders, potentially leading to a material direct or indirect financial impact on the entity”. Similar language is used by Morningstar, MSCI and others. These material risks and opportunities manifest as operational, reputational, legal, policy and regulatory factors that can all affect the bottom line.
And there are good reasons to be concerned about Tesla as an investor. While Tesla has been a darling for much of the ESG world as a major EV manufacturer, there are valid and growing concerns about working conditions and how it has responded to racial discrimination in its workforce. There are also questions about how Tesla has dealt with safety concerns related to autopilot crashes. The lack of decisive leadership on these issues is concerning and it is not surprising that its ESG rating would have declined in some ratings frameworks.
That said, while S&P dropped Tesla from its ESG index, the stock is still a component of many other ESG indexes and ETFs. For example, it has the fifth-largest weighting within the iShares ESG Aware MSCI USA ETF, an ETF with nearly US$22-billion in assets under management. Sustainalytics, owned by Morningstar, gives Tesla a medium risk rating. According to MSCI’s ESG Ratings and Climate Search Tool, Tesla has an “A” rating, and is considered average among more than 40 other automobile companies in the sector.
Our point here is that the disparate evaluations should not be a cause for consternation or concern. There is no reason to expect or to wish that ESG ratings are any more uniform or correlated than traditional financial ratings. As an industry, we are very comfortable with certain equity analysts giving a buy rating while others give a hold or sell rating.
Whatever your take on Tesla, there is no such thing as an ESG company – ESG simply represents the non-financial data set used by teams like Honeytree in our security selection. ESG ratings provide valuable data and some perspective, but these are not a substitute, and nor should they ever be, for judgement. Speaking from our perspective, Tesla has never made our portfolio at Honeytree because it hasn’t met our financial and non-financial (ESG) requirements.