The outperformance of ESG indices recently can be explained in part by what sectors it focuses on: [Vincent] Deluard found that ESG weights more towards the healthcare and technology, which have both outperformed the wider US equity indices over the past few years thanks to their higher returns-on-equity and relatively low capital intensity. But the defining characteristic, by an “order of magnitude 100 times higher than any other input”, Deluard told us, is that these companies also have far fewer employees than the Russell 3000: Here’s Deluard’s rather colourful explanation: ESG’s bias against humans is probably unconscious, but it is a feature, rather than a bug. Companies with no employees do not have strikes or problems with their unions. There is no gender pay gap when production is completed by robots and algorithms. Biotech labs where a handful of PhDs strive to find the next blockbuster molecule have no carbon footprint. Financial networks which enjoy a natural monopoly in processing payments can have the luxury of ticking all the boxes of the corporate governance checklist.

It’s not hard to think of examples of businesses that have relative few employees relative to their value. For instance, when WhatsApp was purchased by Facebook for $19bn in 2014 it only had 55 employees, that’s a market capitalisation-to-employee ratio of $345m. For comparison, Deluard points out that at last Friday’s close, Southwest Airlines’ 133,700 employees only contributed $29,917 each in market cap — under a third of the company’s median salary of $101,302 in 2019, according to its last proxy statement.

Deluard’s work points out two things which are becoming increasingly clear in ESG indices. The first is that by excluding companies on one metric, say their relative carbon footprint, you are becoming overweight another metric which may unintended second order effects….ESG filters unintendedly reward the greatest illnesses of post-industrial societies: winner-take-all capitalism, monopolistic concentration, and the disappearance of jobs for normal people.

ESG without the ‘S’ | FT Alphaville