Is Your ESG Portfolio a Sugarcoated Fantasy Land?

A popular approach to socially responsible investing today is to look at what are considered the most socially responsible companies in each industry, give them ratings based on available data and comparisons, and include those with the highest marks in a socially responsible investment portfolio. For example, as part of this portfolio you might invest in the best tech company and the best healthcare company, but also the best oil company and the best firearms manufacturer etc. You get the idea.

It kind of makes sense… if you care more about appearances than you do about humanity.

I believe the objective of socially responsible investing in its truest sense should be to invest in the corporate actors that contribute the most to humanity's collective wellbeing while forsaking entirely those that, on the whole, endanger it – even if they do it less than the competition. Otherwise, it's kind of like going to the supermarket, checking food labels and deciding to buy the ingredient for your dinner recipe that proclaims on its packaging "Less arsenic than other leading brands!"

An extreme yet simple example can clarify the fatal flaw with this approach. If the investing philosophy of choosing the least-bad corporate actor per industry were around in the 1700s, it could have supported investing in the "best" slave trading company. "This company treats its slaves the best!" an ESG ratings analyst from that era might have declared on his or her report. "A+."

There are a good number of major investment research firms and managers (whom I will not name and shame here) that put forward ratings and portfolios based on this flawed concept. One might argue that what they're doing is, at the very least, a step in the right direction. After all, isn't some social responsibility better than none? Their failure, however, to take the logic of caring about people to its most earnest conclusion is, to me, disappointing. I believe some industries don't deserve to be invested in. Period. If the best company in an industry is actually destroying value for humanity overall, even after accounting for all of its positives – the profits, jobs and satisfied customers it generates – then do you really want that company in your socially responsible portfolio? Is your portfolio truly conscientious or just one big greenwashed compromise for humanity?

About the Author

James Katz, founder and CEO of Humankind Investments, is an experienced quantitative equity analyst and data scientist with a passion for socially responsible investing. He got his start in the ETF industry as a quantitative equity analyst and data scientist at Vanguard, before founding Humankind. He holds a PhD in Business Administration from Stanford University's Graduate School of Business and a BA in Psychology and PPE (Philosophy, Politics and Economics) as well as a BAS in Computer Science from the University of Pennsylvania. James is a CFA charterholder.