Why enlightened investors need to escape ESG’s extractive logic

In 2019, McDonald’s beef-heavy supply chain generated 54 million tonnes of emissions. This is more greenhouse gas emitted by either Portugal or Hungary, and a 7% overall increase in just 4 years. In 2021, MSCI upgraded its ESG score: dropping carbon emissions from its ESG calculation (climate deemed neither a ‘risk’ nor an ‘opportunity’ to McDonald’s business model) and crediting its installation of an undisclosed number of recycling bins in the UK and France.  

In 2020, fast-fashion giant Boohoo was embroiled in scandal after Covid ripped though its factories, exposed inhumane labour conditions at its proudly ‘onshored’ garment factories. Just weeks before The Sunday Times broke the story, MSCI re-confirmed the AA rating which ranked it among the top 15% of its peers, attracting investment from various sustainability conscious funds. Sustainalytics praised its ‘very strong social supply-chain standards the weekend before the story broke.  

These are not exceptional examples. They are not secrets. Yet for the last two years, more capital has flowed into ESG funds than ever before. Amidst the numerous, inconsistent and unregulated ranking systems that abound, no company features more dominantly than MSCI. 90% of the S&P 500 now feature in ESG funds, built with MSCI’s ratings. Between 2020 and the end of 2021, 155 of those companies, including McDonald’s, received upgrades. Yet excoriating analysis by Bloomberg Businessweek found over half of these upgrades were nothing more than ‘surfing the wave’ of rewriting, methodology changes, or similar tweaks, which overnight scrubbed McDonald’s carbon footprint off the planet. Governance, the most cited category of improvement, often entailed nothing more than implementing legally-mandated anti-corruption and data security protocols.  

This state of affairs appears nonsensical. Critics are quick to blame individual fallibility – the wilful blindness of investors reluctant to scratch the surface of solid green stocks – or systemic cynicism, noting the ease with which big business games these systems like all-stars, generating short-term flows from a growing pools of conscientious investors. But a deeper and more troubling truth is that these behaviours are the predictable outcome of a Big Index which was never designed to measure impacts on the Earth and society. ‘In fact’, Businessweek notes, ‘they gauge the opposite: the potential impact of the world on the company and its shareholders’. This is not, per se, wrong. Measuring ESG exposure is a crucial aspect of any responsible long-term business. Yet it cannot alone be a measure of truly sustainable value, because of the simple fact that ESG rankings do not exist to help companies enrich the world, but to assess if the world can continue to enrich the company. This extractive logic is the engine of ESG. In this way, Businessweek observes, a measure like ‘water stress’ does not indicate the strain a factory may place on surrounding rivers (toxic flows, indeed, are not penalised); but whether the rivers have enough water to sustain their factories.  

Enlightened investors, then, face a conundrum. Not only do such rankings fail to measure the potential of these companies to generate long-term value; they often mask behaviours which jeopardise it. This system cannot be right. The paradoxes it nurtures cannot be right. Its ubiquity, for those truly seeking the world’s exceptional companies, cannot be right.   

At Arisaig, we believe there is no right answer. We don’t believe in perfect systems, or perfect companies. But we do believe that there are companies for whom the perverse logic of the ESG industry and the tactical workarounds it inspires is simply anathema to their world-view. Companies which strive for continuous improvement in the value they create for stakeholders, society and environment, generation after generation, because this can be the only way a company earns the right to grow forever; which set targets to reflect the scale of their vision, not to skim the barest requirements. We call these Purposeful Growth businesses. They are rare, and valuable, and they are the businesses on which we seek exclusively to build our patient, buy-and-hold universe; participating in their compounding growth, year after year, with dedicated stewardship that supports their journey to enlightenment. 

And yet. Many of these companies would not earn a high ESG score. Why? In part, because these systems are designed to favour Western, SEC-style reporting protocols (protocols furnished, most often, by dedicated, well-endowed teams). Mostly, because they are simply not designed to assess the net value an organisation creates within the context in which it operates.  

One of our long-term holdings in India is such an example. ‘Goodness’ has become the principle with which this company not only serves more than a billion consumers in Asia, Africa and Latin America, with high-quality, affordable products –many of them, like ultra low-cost anti-malaria products and soaps, essential to equitable health in a post-pandemic world – but the principle that guides their ambitious SDG-aligned targets. In ten years, they have slashed waste and emissions by over 50%, and sourced over 50% of energy from renewables. Product innovation prioritises affordability and lighter footprints. Most striking, perhaps, as an example of its multi-stakeholder approach, are the youth training programmes it provides – cultivating financial independence, gender equality and stronger communities long term, while introducing the company’s products to the next generation of customers. And yet, with a BB rating unchanged since 2018, this company currently scores lower than Philip Morris, with a BBB ranking.   

We identify such companies precisely because we do not have to rely on the piecemeal calculations and scraped data sets which underpin the majority of ESG-labelled funds. Our tightly constructed universe, narrowly trained on singular businesses we intend to hold for at least ten years, gives us the luxury of time to execute our robust Research Excellence methodology: refined for over 25 years and focused solely on the needs and wants of emerging market consumers. This process seeks Growth (companies with the potential to grow forever), Quality (companies with the potential to grow forever) and Alignment (companies with the intention to grow forever). It immediately screens out high harm industries (tobacco, pornography, weapons), and industries with contextually high ESG-exposure (e.g. high-sugar products in health strained markets). Having identified potential businesses, our analysts embark on a process of 360-degree evidencing, with deep local expertise and on-the-ground access, which blends quantitative rigour with exhaustive stakeholder interviewing. We stress-test individual assumptions via a stage-gated process which mandates collective challenge before a case can be progressed. Once we invest, we actively monitor company performance and identify emerging ESG or strategic risks, engaging constructively with at least 60% of our holdings every year, to help them adapt to the needs of the changing world – from improving gender equality on their boards, to supply chain resilience, to climate change mitigation. This is what it takes to identify and nurture Purposeful Growth companies, and deliver long-term compounding returns. No games. No spin. Just long term vision, partnership, and continuous progress.  


This material is being furnished for general informational and/or promotional purposes to professional investors only. The views expressed are those of Arisaig Partners and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact, nor should any reliance be placed on them when making investment decisions. This material does not constitute independent research and is not subject to the protections afforded to independent research.

The statements and views expressed herein are subject to change and may not express current views. Arisaig Partners makes no representation or warranty, express or implied, regarding the accuracy of the assumptions, future financial performance or events. Emerging markets are generally more sensitive to economic and political conditions than developed markets and may be more volatile and less liquid than other investments.

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