PG&E Exposes the Pitfalls of Virtuous Investing
(Bloomberg Opinion) -- If you’re baffled by environmental, social and governance investing, PG&E Corp.’s recent troubles are likely to raise more questions than answers.
The California power company has been devastated by wildfires that ripped through the state in 2017 and 2018. PG&E’s liabilities are estimated at $30 billion and a bankruptcy filing is imminent. Its stock has tumbled 89 percent from its high on Sept. 11, 2017, through Wednesday.
Not to be confused with socially responsible investing, which avoids businesses that some investors find ethically or morally questionable, such as tobacco, gambling or weapons, ESG attempts to identify companies that are exposed to higher-than-average environmental, social or governance risks. The idea isn’t necessarily to beat the market but to engineer a smoother ride by limiting investment in high-risk companies.
It’s a worthwhile endeavor, but it’s easier said than done. The strategy didn’t flash many warnings around PG&E, and it’s not the first time a company has turned out to have crucial vulnerabilities that failed to show up on ESG’s radar.
PG&E shows how tricky it can be to foresee a company’s pitfalls — even after they show up. Regulators are still trying to determine whether PG&E contributed to the fires or whether climate change was to blame, as the company contends, or some combination of the two. And even if the culprit can be identified, it won’t be clear how likely it is to strike again.
Those challenges aren’t unique to PG&E. ESG looks at how various environmental, social and governance factors have affected companies’ stock prices in the past. But that doesn’t mean those factors will be relevant in the future or that the most important risks have been accounted for.
That appears to have been the case with PG&E. According to a summary of ESG ratings compiled by Bloomberg, PG&E scores better than average among its peers for environmental factors. It also has a better-than-average ESG rating from RobecoSAM and Sustainalytics, two of the best-known ESG ratings firms.
It wouldn’t be the first time a company with respectable ESG ratings turned out to have unforeseen problems. Facebook Inc. shows up regularly in ESG funds and is still among the top 10 holdings in the iShares ESG MSCI USA ETF. But it’s now clear the company wasn’t entirely forthcoming about its privacy policies, and its stock has plunged 34 percent from its high on July 25, 2018, through Wednesday. Facebook’s ESG ratings appear to have undersold that risk or failed to account for it at all.
Granted, a high ESG rating doesn’t mean a company is infallible, and no system of risk detection can identify every vulnerability. But it’s not clear that a broader ESG strategy would have reduced risk in any meaningful way. In the U.S., for example, stocks of companies with high ESG ratings have been more volatile than the broad market, not less. The annualized standard deviation of the MSCI USA ESG Leaders Index was 15.1 percent from 2001 to 2018, the longest period for which numbers are available, while that of the MSCI USA Index was 14.5 percent. The ESG index also lagged the broad market index by 0.4 percentage points a year during that period, including dividends.
And in developed countries outside the U.S., the risk reduction was negligible. The MSCI World ex USA ESG Leaders Index had a volatility of 17.8 percent from October 2007 to 2018, compared with a slightly higher 17.9 percent for the MSCI World ex USA Index. This time, the ESG index beat the broad market index by 0.6 percentage points a year.
I suspect that ESG will get better at identifying risk over time. In the meantime, investors are paying a lot to experiment. I spotted 61 mutual funds with ESG in their name, including their various share classes. Their average expense ratio is 1.1 percent a year, a hefty fee in the era of zero-fee funds.
There are few opportunities for fund companies to charge those kinds of fees, so expect ESG funds to proliferate. And as they do, investors will have to decide whether to wager that ESG can spot the next PG&E before it’s too late.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.
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