ESG Likes Value Stocks, But CO2 Scores Don’t

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ESG Likes Value Stocks, But CO2 Scores Don’t

Which company do you think has a better MSCI ESG (Environmental, Social and Governance) rating, ExxonMobil or Facebook? You’re smart enough to know a trick question when you see one so, yes, the answer is ExxonMobil.

The funny thing is that it’s not even close. XOM is BBB rated, and FB is B. These rankings work the same way as bond rankings, so BBB is “investment grade” and B is solidly “junk”.

Here are a few other prominent names and their current ESG ratings/recent upgrades and downgrades, categorized by MSCI’s broad classifications:

ESG “leaders” (AA – AAA):

  • Microsoft: AAA, a rating it has held since 2016. (Only 3 percent of global companies are AAA rated.)

“Average” (A – BB)

  • Tesla: A, down from its 2017 AAA rating and AA in 2018
  • Apple: currently BBB (as of December 2020), down from the A ranking it had from 2016 – 2019
  • Amazon: BBB, after an upgrade in 2020 from BB
  • JP Morgan: BBB, up from the BB rating it held from 2017 – 2020
  • Google: BBB, after a 2-notch downgrade in December 2020
  • Disney: BBB since 2017
  • Berkshire Hathaway: BB since 2017
  • Walmart: BB, downgraded from BBB in December 2020

“Laggards” (B – CCC)

  • Pfizer: B since 2018, CCC before
  • Moderna: B, first rated in 2020

As you can see, even though these rankings are algo-driven they are all over the map and that’s important because ETF sponsors like iShares use them both in product development and ESG disclosures. Why MRNA and PFE have such low ESG ratings after helping develop 2 important vaccines is not exactly clear on the MSCI website (link below if you want to pursue this further).

The reason we’re bringing all this up now is because we had a thought over the long weekend: “how will increasing interest in ESG investing skew “Growth” and “Value” style returns this year and beyond?” Our intuition was that Growth has a real ESG edge (fewer fossil fuel companies, perhaps more focus on workplace issues, etc.).

The truth is something different, however, as these 3 points highlight:

#1: In large caps, Value has much better ESG scores than Growth. The numbers, based on iShares’ aggregation of the data:

  • The S&P 500 has a BBB rating and a 5.2 MSCI ESG Quality Score (range of 0 – 10)
  • The S&P 500 Value Index (iShares symbol IVE) has an A rating and a 6.0 score
  • The S&P 500 Growth Index (IVW) has a BBB rating and a 4.4 score

#2: In small caps, however, there is no difference in ESG ratings between Growth and Value:

  • The Russell 2000 has a BB rating and a 4.1 MSCI ESG Quality Score. (Note: much lower than the S&P 500)
  • Both the Russell 2000 Growth (iShares symbol IWO) and Value (IWN) have exactly the same ratings and scores as the overall small cap index.

#3: If you’re mostly focused on the “E(nvironmental)” side of ESG, the MSCI Weighted Average Carbon Intensity measure of “Tons of CO2E/$M Sales” (the E is for “estimated”) does show a dramatic preference for Growth over Value:

  • S&P 500: 141.1
  • S&P 500 Growth: 54.8
  • S&P 500 Value: 236.3
  • Russell 2000: 126.1
  • Russell 2000 Growth: 62.6
  • Russell 2000 Value: 198.0

Takeaway (1): ESG as an investment style has a marked preference for Value names in large caps but doesn’t see any difference between small cap Growth and Value.

Takeaway (2): ESG as an investment concept is a bit like a Rorschach ink blot test – people see different things – so other measures like carbon intensity may also grow to matter more in the future.

Final thought: since we are fundamental analysts at heart, ESG investing doesn’t fit easily into our mental models but we know its growing importance demands we find a place for it. We’ll keep pondering what ESG might do to stock valuations over time and certainly welcome your comments on the subject.

Sources:

Corporate ESG Rankings: https://www.msci.com/our-solutions/esg-investing/esg-ratings/esg-ratings-corporate-search-tool/issuer

iShares data (IVV highlighted here): https://www.ishares.com/us/products/239726/ishares-core-sp-500-etf