Market Insights | 5 min read

    ESG–The Beginning of the End?

    “It happens every time. They all become blueberries.” – Willie Wonka

    This Tuesday morning, the Frankfurt offices of Deutsche Bank and DWS, the asset manager owned (80%) by Deutsche Bank, were raided by German police as regulators have moved in after investigating claims that DWS has been engaged in the practice of “Greenwashing” since January.

    Unfortunately for DWS, the claims came from former DWS Sustainable Investing head, Desiree Fixler, who was fired by the company in March 2021. DWS claimed at the time that Ms. Fixler had not made enough “progress” with her unit’s initiatives. One of the potential reasons Ms. Fixler was fired was that she had serious problems with the amount of assets DWS labeled as “ESG Integrated."

    In their 2020 Annual Report, DWS claimed approximately $450 billion (about half of total assets under management) in investments were governed by environmental, social, and governance criteria. While DWS removed Ms. Fixler, DWS reduced the amount of ESG investments by 75% in the 2021 Annual Report. That amount of reduction is shocking when you consider that ESG is in hyper-growth mode. Not a good look.

    Additionally, Ms. Fixler claimed DWS made misleading and false statements in customer marketing materials and prospectus. Most probably the real reason Ms. Fixler was let go was that DWS wanted to jump into ESG feet first and improve rather lackluster performance and as head of the division, she blocked the strategy with the pesky attribute of integrity.

    Therefore, yesterday DWS was raided by federal police and the German financial regulator BanFin. The police usually do not raid you in these situations unless they have concrete evidence that you’ve been naughty. I am sure that BanFin has uncovered all kinds of communications internally and perhaps externally where sustainable investing is, to put it professionally “called into question." It should also be noted that our own SEC is also looking into “Greenwashing” on currently unnamed targets.

    Commenting on the raid the Frankfort prosecutor’s office stated, “After examination, sufficient factual evidence has emerged that, contrary to the statements made in the sales prospectuses of DWS funds, ESG factors were not taken into account at all in a large number of investments.” The prosecutor’s office also added that DWS engaged in “prospectus fraud."

    Last year, Ms. Fixler sat down for an interview with Forbes, and she presented what she referred to as “Seven Principals for ESG Investing”. All seven were good but number four really caught my attention:

    “Have An Integrated Process for Constructing ESG Products. Constructing a legitimate ESG product isn’t something that can be done by having a lonely island of people in the sustainability function giving the marketing people some language to put in a fund prospectus. Critically, portfolio managers who make the ultimate asset management decisions have to be involved. Saying a product is green because the portfolio manager constructing it had access to ESG data isn’t the same thing as saying that the portfolio manager used these data in constructing it. The portfolio manager should be held accountable for both the financial and ESG performance of the fund. She or he should also be able to answer any questions about how the fund was constructed and respond to any concerns raised, such as regarding the sources of ESG data, how they were aggregated, and the decision rules for determining what stocks are in and out of the fund.”

    It seems very plausible that Ms. Fixler is referring to the problems at DWS by, “giving the marketing people some language to put in a fund prospectus” front and center.

    To imagine the type of things that would be a problem with the ESG process, I looked at the largest DSW ESG fund, ESG Core Equity to see what they own and consider ESG. I noticed that the top five holdings, which make up approximately 29% of the fund, look like the top of the S&P 500. We have:

    DWS - Apple, Microsoft, Alphabet, Cigna, Exxon


    SPY – Apple, Microsoft, Amazon, Alphabet, Tesla

    A bit different. The top five for SPY make up about 19% versus the previously mentioned 29% for DWS. I’m not sure why Apple leads the pack in the ESG fund other than they always manage to create the image of granola-eating, sandal-wearing hippies as opposed to the ruthlessly genius company that supposedly has a mountain of spent batteries somewhere in China!

    What is kind of weird is Exxon. Would you put a fossil fuel giant in an ESG fund’s top fice holdings? What is really striking though (besides the 5.75% front load of DWS ESG Core Equity Fund) is that compared to the industry leader in ESG investing, BlackRock’s iShares, DWS looks relatively good. DWS has “ONLY” three fossil fuel giants in their fund (out of 88 companies held) and they actually have one renewable energy company, Enphase Energy, who makes up a respectable 1.14%.

    Alternatively, iShare's ESG Aware MSCI screened fund (ESGU) has 16 American fossil fuel giants and just one renewable energy firm that only makes up .18% of the fund, a token clean-energy company if you will. Moreover, the iShares ETF number one industrial holding is Raytheon (.55% of the fund), who, last time I checked, make things whose sole objective is to destroy things and kill people!

    Both funds maintain positions in Dupont and Newmont Mining, not exactly guardians of the environment. However, iShares piles it on with companies like Dow, Amcor, Nucor, PPG, and Sherwin-Williams. The point here is, if you think the guys who just got raided (DWS) are bad, their larger competitors are even worse and might get a little “raiding” themselves.

    I believe that what ails the ESG investment sector is relatively simple. There really are not enough real sustainable investing investments out there to meet the nearly insatiable demand. There are large, sovereign wealth funds out there cruising the earth for real sustainable investment projects and probably after around $1 trillion, we ran out of real sustainable investments.

    Meanwhile, if you are in the fund management business and everybody wants the same thing if there is none left you simply “make more." Just like in the Great Housing Crisis when The Street ran out of real borrowers and real loans to stuff into securities that investors were clamoring for, they just made up borrowers and created derivatives that reference real loans. With ESG, a few big indexing companies like MSCI came along with a rating system that everyone seems to use but no one understands to “screen” companies for their ESG worthiness. Companies like MSCI blessed them and viola, $30 trillion of investments and counting! The funds management industry is making millions in fees filling the need for these investment products.

    Up until this Tuesday in Frankfort, everything was simply conjecture. You knew that hanky-panky was going on, but the industry had enough cover to make even the most ridiculous (Raytheon) ESG investment safe. However, now that authorities have raided one of the ESG sausage factories, the true farce is going to have a bright light shined on it. Also, the SEC and BanFin have been passing notes back and forth to each other and the SEC finally seems to be hot on the trail too.

    Unraveling a $30 trillion scam is going to be interesting.

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    John Tuohy

    John Tuohy is CEO of SWBC Investment Services, LLC, a Broker/Dealer and SWBC Investment Company, an SEC Registered Investment Advisor (RIA). In his role, John is responsible for identifying, developing, and executing the division's strategic plan and all business development, sales, and marketing activities.

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