November 2022 IssueLong scroll reading

What is the color of your portfolio?

By Mark Freeland

One can take a cold, analytical approach to environmental (and other) concerns. One can also be motivated by an emotional connection. Being a generally dispassionate investor, I took last August to reconnect with nature, to hug a few trees, as it were.

I visited South America, going early morning birding in the Amazon,
swimming (snorkeling) with the fishes (and sea lions and tortoises) in the Galapagos,
and watching the llamas (pronounced “yamas”) hopping around in the Andes. Making them the original Yamahoppers

Regardless of why people are concerned about the environment, it’s not hard to understand why many view climate change as an existential threat, regarding all else as secondary. In October 2022, an international team led by Oregon State University researchers concluded that the Earth’s vital signs have reached “code red,” with 16 of 35 planetary vital signs they use to track climate change at record extremes. Especially for younger people, the sense of inheriting an irreparably damaged planet is remarkably widespread, with two-thirds of younger adults reporting that their concerns intrude on daily life and are damaging their mental health. For such investors, it may be best to look at funds that focus exclusively or primarily on companies actively working to improve the environment. For others, the environment may just be one of many concerns driving their portfolio.

This issue has become deeply entangled – hopelessly, some fear – in politics and marketing. Marketers anxiously rushed to market “green-lite” funds that sort of did something kinda … you know, green, in the desperate attempt to capture investors’ eyes and wallets. And just as the tide of lite-green funds reaches its max, conservative politicians rail against the idea of contaminating a purely financial decision by considering externalities such as the environment. Nineteen states have begun an inquiry into Morningstar’s conduct, and that of its Sustainalytics subsidiary and have moved against BlackRock for using “the hard-earned money of our states’ citizens to circumvent the best possible return on investment …”

For those who have not been obsessing about the color of their investment portfolio, what follows is an approachable review of some of the issues and opportunities you face in trying to decide whether, and if so, how to align your portfolio with your other priorities.

Building an ESG portfolio

Depending on how a fund or rating service defines ESG, the process of constructing a portfolio may vary. It generally involves some or all of these steps: evaluating companies in terms of environmental, social, and governance factors; combining these evaluations to either “score” companies or to define an acceptable universe of companies from which to select investments; selecting and weighting companies for a fund’s portfolio.

The choice of how each step is done and how stringently standards are applied results in a wide assortment of ESG-labeled portfolios. These range from funds where the label is little more than marketing to funds strongly focused on, to use a buzzword of the day, “impact.”

ESG factors can be evaluated through a purely financial lens and/or with an eye toward impact, e.g., carbon footprint, waste reduction, etc.

Risk exposure

Taking a purely financial perspective means looking at a company’s ESG risks and the actions it takes to mitigate those risks. An example of an institution that looks at companies only from this perspective is Sustainalytics (a Morningstar subsidiary). This short YouTube video gives an overview of its approach.

ESG financial risks vary from industry to industry. The fossil fuel industry obviously has a great deal of environmental risk exposure. Social media companies face social risks from privacy concerns, hate speech propagation, and more. The theory is that despite these differences, these risks and how the companies mitigate them can be quantified in purely financial (dollar) terms. ESG risk is treated as just another investment factor to consider, like momentum or company size.

Often a pure risk assessment methodology is applied using lax standards. As explained in this recent NY Times Op-Ed article, when the focus is on financial risk, companies like Exxon (XOM) can wind up with high ESG marks.

There is nothing inherently wrong with incorporating ESG risk into financial evaluations of companies. In this day and age, one would expect no less of a fiduciary. It is the branding of this run-of-the-mill risk assessment as ESG that is questionable. This is why the SEC is proposing more extensive disclosures by funds that market themselves as ESG.

Relative impact

Other methodologies do look at the impact that companies have. They may compare companies on an absolute scale, e.g., which company has a smaller carbon footprint independent of its business. Or they may grade companies on a curve, looking at how good they are relative to their industry peers. Effectively they accept the “best of the worst.”

Shell is included in many ESG lists, as it is one of the better (less bad) fossil fuel companies. The linked WSJ article describes how promising Shell’s plans are relative to other oil companies. A question is how well and how quickly companies fulfill their promises. A recent study reported by NPR says that Shell, along with Exxon, Chevron, and BP, are largely just pledging action, “and the companies remain financially reliant on fossil fuels.”

These are fossil fuel companies, after all, so that last comment is to be expected. Still, it gives one pause to think that some of these companies would be praised simply because they’re not as bad as their peers.

Old style screens

Rating institutions or fund companies often take a hybrid approach, incorporating financial scoring and exclusionary screening. One would expect an approach incorporating a fossil fuel screen to rule out companies like Shell. But there are chinks in this armor as well. With energy companies doing so well (at least until a few months ago), funds have been under pressure to reevaluate their screens.

The Financial Times recently wrote that the “Energy crisis prompts ESG to rethink on oil and gas. … Six percent of European ESG funds now own Shell, compared with zero percent at the end of last year, according to Bank of America. … ‘We believe [some] ESG funds are revisiting the cost of exclusion [of energy companies’ giving their underperformance in the first half of 2022” … [said BofA]”.

It went on to mention a new European law designating gas and nuclear energy as sustainable. That is consistent with the Biden administration providing new subsidies for existing nuclear facilities. From a relative perspective, gas and nuclear can be cleaner than oil and coal. (Interesting bit of useless trivia: geothermal energy comes primarily from radioactive decay; only a small portion is gravitational.)

The 20% solution

If one looks hard enough, one can find some really odd companies in ESG funds. Blackrock Sustainable Advantage Emerging Markets Equity Fund (BLZIX) even opened a position in PetroChina earlier this year (comparing its July 31st 1st quarter report with its April 30th annual report).

It’s not a large position, but it certainly raises eyebrows. My best and only guess at this point is that funds are free to invest 20% of their assets in almost anything, even if it goes against the fund’s objective. Most of the time, these quirks are not something to be concerned about, but it is still worth a quick look to see what’s lurking in your fund.

Absolute impact

Some fund companies, rather than relying on major institutions like MSCI and S&P, do their own research and are intrinsically committed to ESG objectives. Domini speaks of its “deep research in environmental and social issues.” Calvert says it “has one of the industry’s largest and most diverse teams of ESG professionals, spanning research, engagement [‘to drive positive change’], and investment solutions. Parnassus combines exclusionary screens with in-house ESG analysis and active engagement.

This is just a list of some of the usual suspects. It is not an endorsement. It’s also not intended to imply that these companies never make missteps. Parnassus continued to own Wells Fargo for at least a couple of years after the bank’s cross-selling scandal came to light. Arguably it tried to work with Wells Fargo until it felt that it could do no more. One of the seemingly contradictory aspects of active engagement is that in order to influence a company, you need to own shares. A lot of shares.

Parnassus immediately began using its substantial holding in the firm to engage top executives. We met with Wells Fargo management – including the CEO and key independent Directors – multiple times to share our perspective on events and suggest potential remedies. We also voted our proxy shares according to our responsible investment policies …

It is important to note that aside from exclusionary screens, even funds focused on making a positive impact may invest in “dirty” companies. They look at what companies are doing now to improve (as opposed to making promises) and how much of an impact that has. A large manufacturing company making significant improvements can have a bigger impact than a low greenhouse gas emissions financial services company reducing emissions further.


In July, Morningstar published a story describing and comparing four ESG indexes: MSCI USA Extended ESG Focus, FTSE4Good U.S. Select, S&P 500 ESG, and Calvert US Large Cap Core Responsible Index. While it doesn’t discuss the scoring method these indexes use (relative scoring), it details the specific screens used by each of the indexes and compares relative performance.

It has no surprises. The less one excludes from a fund or index, the closer its performance tracks that of its benchmark, here the S&P 500. Long-term performance tends to be neither better nor worse, just a little different.

If you have a particular concern, an industry you want to avoid, or one you want to invest in, you may be better off looking for funds specifically using your desired screens. A site that can help identify such funds is

After doing some research for this piece, I’m not all that confident that investing in a fund simply because it is labeled ESG is much better than investing in a random fund. Look at the top holdings and sectors in a fund. If anything looks strange, dig in deeper to see how the fund decides which companies it invests in. Or invest through a family that exists to invest “responsibly” rather than through one that offers ESG funds for its investors as just some more choices.

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About Mark Freeland

Hi, I’m Mark Freeland and if you read the MFO Discussion Board (as you should), you’ll know me as msf. I too am a personal investor who learned about investing over time, following the adage that if you want something done right, do it yourself. At least if one can. Mathematical, scientific, software background, so analytics come pretty naturally to me. I fell into a CFO role at a four-person startup a few years ago, I think because I was the only one who could open a spreadsheet. Prior to that, I'd been on employee committees (again in small companies) recommending 401k investment options. My hope for the months ahead I might share my thoughts about the mechanics of investment vehicles and new developments as they arise.