MW If you want to invest in helping the environment, don't bother with ESG funds
By Brett Arends
Companies with good 'environmental, social and governance' ratings are actually worse for the environment
Companies in the S&P 500 with high ESG ratings actually produced 12% more carbon emissions than their lower-rated industry peers.
If you want to use your retirement savings to help prevent the climate crisis from getting worse, don't invest in "environmental, social and governance," or ESG, investment funds or strategies.
Rather, invest in strategies focused specifically on environmental issues - such as investment funds that invest in green energy, or in companies that emit less carbon dioxide.
That's the message from a startling new report on ESG investing.
The report is likely to provide further awkward news for the once-fashionable ESG investing industry of consultants, analysts and investment managers already being pummeled by political attacks from the right.
But even though it may also prove gleeful reading for archconservatives opposed to the whole socially responsible investment program, there is a sting in the tail for them, too. (More on that below.)
Companies in the S&P 500 SPX with high ESG ratings actually produced 12% more carbon emissions than their lower-rated industry peers, report professors Panos Patatoukas of UC Berkeley's Haas School of Business and Jinsung Hwang of the Hankuk University of Foreign Studies in Seoul, South Korea.
That's true even though they were specifically making apples-to-apples comparisons, by comparing the carbon emissions of similar firms within the same industry (and not, say, comparing the low carbon emissions of a media company with the high carbon emissions of a power plant).
"We find that ESG scores are unrelated not only to current carbon intensity but also to subsequent changes in carbon intensity," they wrote. "Sector-peer rankings based on ESG scores fail to discriminate among firms on either current or future carbon performance, rewarding companies for appearing more sustainable rather than being - or becoming - more carbon efficient."
The reason for this? "ESG assessments reward disclosure practices and management processes rather than actual environmental outcomes," they noted.
"They overweight 'form' over 'substance,'" Patatoukas told me.
To study firms' carbon emissions, the researchers looked across companies' full value chain, from suppliers to customers, and not just at the carbon dioxide produced by their own operations and purchased energy. (In industry jargon. this is called "scope 3" emissions measurements.) Those indirect carbon emissions produced upstream and downstream by the rest of the value chain accounted for an astonishing 82% of a firm's CO2 output. The data came from firms and from independent third-party analysts such as Trucost, an environmental analytics firm bought by S&P in 2016.
The carbon intensity of the firms was measured as CO2 emissions per dollar of revenues. The analysis avoided apples-to-oranges comparisons by using "factor tilting," a specific strategy which ended up comparing, as far as possible, similar companies within the same industries.
The analysis was based on the years from 2017, when comprehensive full-scope emissions data became available, to 2023, the most recent year for which it was available. It covered 94% of the companies in the S&P 500.
"MSCI ESG Ratings are not intended, designed or optimized to be carbon metrics," commented MSCI $(MSCI)$, a leading provider of ESG and other indexes, in an emailed statement. "MSCI ESG Ratings are designed for one purpose: to measure a company's resilience to financially material environmental, societal and governance risks, and how these could potentially impact their earnings. Investors use other tools to address climate risk. ESG Ratings are not climate ratings."
Financial writer and Substack author Joachim Klement, a market strategist at Panmure Liberum in London, says he isn't surprised by the findings. "If you add too many ESG criteria to your ESG portfolio, you end up making the ESG performance worse," he noted.
And Harvard Business School professor Lauren Cohen points out that environmental, social and governance issues "are separate things," and that putting them together as ESG "is like a peanut butter, jelly and pickle sandwich."
This isn't the first time questions have been raised about socially responsible investing. A few years ago, the manager of a major U.S. state pension fund privately told me he knew some of the scoring had become hinky when he discovered that tobacco industries were getting top scores.
Companies that actually killed millions of their own customers apparently could still be rated excellent for their socially responsible corporate policies - so long as they, say, did a lot of recycling, planted plenty of trees and had terrific diversity initiatives.
You can see how it happens, and you can even see the rationale. But you can also see why, to many people, it sounds completely nuts.
But while the latest study raises new questions about how socially responsible investing is done, it doesn't invalidate the idea. Far from it.
Using the same data, Patatoukas and Hwang found that a comparable carbon-efficient index that looked only at firms' CO2 outputs was able to slash those greenhouse-gas emissions by an astonishing 40%.
And this, too, is based purely on an apples-to-apples comparison between similar firms in the same industry. This carbon-efficient tilted index has the same industry and sector exposures as the S&P 500.
Furthermore, the researchers found that ESG tilting and carbon-intensity tilting both did little or nothing to undermine investment performance.
"In financial terms, the ESG-tilted and carbon-efficient indexes generate average annualized returns of roughly 14%, comparable to the standard S&P 500 benchmark," they wrote. (Actually, from 2017 through 2023, the SPDR S&P 500 Trust SPY produced compound annual returns of 13.3%.)
The only negative was that both the ESG and carbon-efficient tilted portfolios generated higher turnover of shares, and therefore higher transaction costs.
News that you can slash carbon emissions by 40% without hurting financial performance is little short of remarkable. Expect to see this part of the story played down by politicians playing to the peanut gallery by attacking socially responsible investing.
It's only weeks since President Trump signed a new executive order launching investigations into two Wall Street consultancies, allegedly because they promoted ESG or DEI investing. (It was pure coincidence that the two consultancies named had just advised investors to vote against his buddy Elon Musk's $1 trillion pay package at Tesla $(TSLA)$.)
Republican Florida Gov. Ron DeSantis made attacking ESG and "woke capitalism" a big part of his shtick. It's now nearly four years since he promised to ban it from Florida's pension funds. It was a bold idea - except that, as MarketWatch revealed at the time, Florida pension funds weren't using ESG ratings, and legally weren't even allowed to. So DeSantis was promising to stop something that wasn't happening.
But as hardly anyone checked, he got the headlines all the same. That's modern life for you - form over substance.
-Brett Arends
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(END) Dow Jones Newswires
January 15, 2026 07:00 ET (12:00 GMT)
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