PG&E’s bankruptcy shows blindspots in green investing
Troubles expose weakness in how investors gauge firms’ commitment to social issues
The bankruptcy filing by PG&E Corp. is the latest stumble by a company rated highly by environmentally focused investors, further exposing a weakness in a scoring system meant to measure risk for shareholders.
The California utility’s moves over the past 10 years to rely more on renewable sources such as wind and solar resulted in high scores on environmental, social and governance metrics, which are considered by many investors to be a positive factor in choosing a stock and used by others as a way of managing risk.
What the ratings couldn’t predict is that the stock would lose nearly 70% of its market value since early November, as investors worried about potential liabilities for the role PG&E’s equipment may have played in multiple wildfires. PG&E Corp. filed for bankruptcy protection on Jan. 29
Even as the world’s biggest asset managers pile into ESG investing strategies—an estimated $22.89 trillion invested with ESG in mind, according to industry group the Global Sustainable Investment Alliance—the ratings and analysis that underpin sustainable investment scores remain more art than a science.
The data is often self-reported, and there can be blind spots, like those revealed when companies such as PG&E, Volkswagen AG and Facebook Inc. ran into trouble.
“These data providers almost have an impossible task in front of them” because it isn’t standardized, said George Serafeim, a professor at the Harvard Business School. “The whole field is very messy.”
Index and research firm MSCI Inc. and data-analysis company Sustainalytics, now partly owned by Morningstar, are among the leading providers of ESG ratings. The firms say their scores quantify risks presented by key issues in all three ESG categories and how companies manage those risks. MSCI also factors a company’s potential upside in ESG into its rating, something that Sustainalytics has stopped doing for its primary rating.
Both firms evaluate companies on a broad range of issues. Under the heading of environmental, for example, MSCI and Sustainalytics assess corporations on issues such as carbon emissions, rawmaterial sourcing and climatechange vulnerability.
“Many of today’s ESG strategies utilize generic and sometimes not transparent metrics of what it means to be a good corporate citizen,” said Ethan Powell, founder of Impact Shares, which offers exchange-traded funds aligned with the values of various nonprofits. It “contributes to the lack of adoption within the broader investing public.”
Impact Shares works with Sustainalytics, along with other data sources and tools, to annually screen companies for its funds, two of which include PG&E.
As of November 2018, Sustainalytics rated PG&E in the top 10% of its peers in the environmental category, and the firm had singled the California utility out in 2017 as one of 10 companies world-wide best positioned to take advantage of emerging ESG trends.
Sustainalytics has since said that rating was assigned under an old methodology. Beginning in September, it has concentrated its primary ratings on assessing risk. The firm also noted that, in reports before the Camp Fire broke out on Nov. 8, it had flagged the risk of “controversy.”
Investigators are still working to determine what started last November’s wildfire, which killed 86 people, but PG&E has disclosed that one of its highvoltage transmission lines malfunctioned in the area about 15 minutes before the fire started.
PG&E isn’t the only high-rated company that has faced an ESGrelated selloff in the past year. Facebook shares have fallen more than 20% since its peak over the summer, a decline that many analysts attribute to its handling of a data-privacy controversy.
Facebook has long been among the top five holdings in the largest U.S. fund based on an ESG index, the iShares MSCI KLD 400 Social exchange-traded fund. The KLD Social fund traded roughly in line with the broad market during the selloff in the second half of 2018.
Facebook has admitted to mistakes on sharing users’ data and apologized for a failure to move quickly enough to deter circulation of fake news on its network.
Linda-Eling Lee, global head of ESG Research at MSCI, said the firm’s ratings account for how Facebook manages data-privacy concerns relative to its peers.
Similarly, Volkswagen was historically viewed as a strong ESG company before the 2015 disclosure that the German auto maker systematically cheated on emissions tests. In that case, MSCI raised governance concerns about the firm ahead of the scandal and later attributed “Dieselgate” to Volkswagen’s mismanagement.
Volkswagen admitted in 2015 to rigging nearly 11 million dieselpowered vehicles with test-cheating software.
An investor who bought Volkswagen shares in April 2015 would show a loss of more than 35% on the investment.
Some call those companies outliers and point to numerous studies that have found that companies with high ESG scores tend to outperform.
Bank of America Merrill Lynch in 2018 found that by investing in companies with aboveaverage scores, investors could have avoided 90% of bankruptcies
between 2005 and 2017.
But there is a low level of agreement between MSCI and Sustainalytics scoring, Mr. Serafeim said. He noted a less than 50% correlation in scores provided by different ratings firms on the same stocks.
ESG-minded investors are perhaps best served by pairing the ratings with other sources. Mr. Serafeim has tracked scores alongside sentiment about the companies.
Not everyone has the time to find ways to address the shortcomings of ESG ratings, however.
“It’s not that we think it’s a bunch of baloney—we don’t,” said Oliver Pursche, chief market strategist at broker-dealer and money manager Bruderman Brothers.
“Our employees only have so many hours in a day…We’d rather have them go through a company’s balance sheet, the business outlook, the income statement.”