Most of the scorn or disdain with respect to ESG is because it is conflated with sin stocks. The fact that the latter is becoming a thing of the past is something sceptics need to grasp.
Sin stocks refer to shares of companies engaged in a business or industry that's considered unethical, immoral, or loathsome.
Alcohol, gambling, tobacco and pornography are the most common examples. Peace activists may throw in weapons manufacturing while environmentalists might consider oil and coal. Vegetarians might similarly categorise companies that deal in animal products. A vegan may go further and consider companies in dairy production too. Lately, the cannabis industry is often lumped in with sin stocks. Why leave out aerated drinks?
On a practical level, it is evidently difficult to restrict additions to such a list. For one, there is no holy grail. Everyone’s notion of “sin” differs. Of course, if your favourite vice is listed, you should have no problem investing in the respective stock.
On a philosophical level, there are plenty of unanswered questions. Who decides what is a sin? And do you have any right imposing that categorisation on others? Why is drinking wine unethical? If tobacco is legal and the statutory warnings are there for all to see, aren’t the adults who choose to smoke only exercising their free will? If cannabis is legal and the corporations are paying their taxes, why should there be an ethical debate?
Sin stocks are based on negative screening. This exclusionary form of investing is outdated and has given way to a much more holistic and inclusive investing environment.
Say No to sin, say Yes to ESG.
Now investors and asset managers are focused on looking at businesses that have a positive impact on three parameters – Environment, Social, Governance, the ESG acronym. Stocks are evaluated on good company behaviour, rather than the narrow prism of purely controversial end products.
To make it clearer, let’s look at how Sustainalytics, a global leader in ESG and Corporate Governance research and ratings, assigns ESG Risk Ratings. On a spectrum of 0 to 40+, there are five levels of risk:
- Negligible
- Low
- Medium
- High
- Severe
Supported by a robust materiality framework, Sustainalytics' ESG Risk Ratings provide a quantitative measure of unmanaged ESG risk. The above ESG Risk Ratings measure a company’s exposure to industry-specific material ESG risks and how well a company is managing those risks.
ITC: Medium Risk ESG Rating of 27.4
ITC fits in smugly with the “sin stocks” categorisation. The analysts have viewed the negative consequences of tobacco (cigarette selling is its main revenue driver) on societal health and the environment, in conjunction with other hugely consequential issues: waste management, carbon footprint, water efficiency, business ethics, corporate governance, gender diversity, human capital, and factors within the supply chain (human rights, resource use, land use and biodiversity).
Diageo: Low Risk ESG Rating of 15.5
One of the world’s largest producer of liquor, another “sin stock”, is focused on improving its water use efficiency (based on the litres of water used to distil or package 1 litre of product). In 2008, the company set a target of a 50% improvement in water-use efficiency by 2020, using 2007 as the baseline. The distillery in Tennessee now saves more than 30 million litres of water annually and 10 million litres in Canada. It also leads the way by way of women representation on its board.
Big Tech
When it comes to Big Tech firms, corporate governance, business ethics and data privacy and security are what need to be scrutinized in detail. Sustainalytics gives Alphabet a 22.3 Medium Risk Rating as against Facebook’s 31.6 High Risk Rating.
This is what ESG does...
It attempts to capture the complexity of social and environmental systems, and business organizations. It is not narrow, where the fixation is on identifying the final output and classifying it as a sin stock. It goes beyond its 3-letter acronym to address how a company serves all stakeholders: employees, communities, customers, suppliers, shareholders, and the environment.
