Back in 2022, electric car manufacturer Tesla was dropped from the S&P 500 Environmental, Social, and Governance Index. Tesla’s lack of a low-carbon strategy and reports of racism and poor working conditions at its Fremont, California factory affected its score. However, believe it or not, unlike Tesla, oil and gas company ExxonMobil is still included, which can feel counterintuitive. 

As it turns out, ESG has become a buzzword with good intentions but shaky execution. Despite the hype, it’s often more about marketing than impact. However, writing ESG off entirely would be a mistake. With serious reform, clearer standards and less greenwashing, ESG can become what it was meant to be: a tool to align profit with purpose in a world that urgently needs both.

ESG refers to “a set of standards used to measure an organization’s environmental and social impact,” according to technology company International Business Machines. For something meant to guide value-based investing, ESG is surprisingly vague.

The International Organization of Securities Commissions found that “little transparency exists about [ESG] methodologies” and “there is little clarity and alignment on definitions, including on what ratings or data products intend to measure.” The organization also warned of potential conflicts of interest, especially when ESG ratings firms offer consulting or advisory services to the same companies they’re supposed to be objectively scoring.

These issues mean that investors, companies and regulators often don’t know what data was used, how it was weighted or what standards were applied to produce the companies’ scores. 

Even worse, some ESG funds aren’t as different from traditional funds as they claim to be: They often include the same big-name companies as the S&P 500, even if those companies don’t fully live up to ESG standards. A study by EDHEC Business School revealed that “climate data points represent at most 12% of determinants of portfolio stock weights in an average climate fund.” In one major ESG fund, Deloitte reports that nine of the top 10 holdings were the same as the biggest-weighted companies in the S&P 500.

Some ESG funds’ top holdings are almost identical to regular indexes like the S&P 500, suggesting that their criteria aren’t meaningfully influencing investment decisions. The fund appears sustainable without investing resources toward companies that are actually leading in climate and social issues. 

As a result, the fund does little to invest capital in a more sustainable direction. Investors may end up with a portfolio that’s barely different from a traditional one. This is a textbook example of greenwashing — a phenomenon of signaling environmental or social responsibility without backing it up with meaningful action.

Despite its flaws, ESG investing can still serve a valuable purpose. For example, in 2021, activist fund Engine No. 1 led a successful effort to elect three new board members at ExxonMobil to push for a “decarbonizing world.” Even with just a 0.02% stake, they persuaded major institutional investors like BlackRock and Vanguard to support their proposal.

To restore credibility, ESG investing needs a serious makeover. First, transparency must be non-negotiable. ESG ratings should clearly disclose their criteria and methods, especially if the same firm offers consulting services to the companies that it scores. 

Second, standardization is crucial. ESG data tends to be “incomplete, mostly unaudited, and often dated,” according to the Harvard Business Review. In fact, over 70% of executives say they lack confidence in their non-financial reporting.

Lastly, fund managers must be held accountable. ESG-labeled funds often charge 40% higher fees than traditional ones — while offering little in terms of differentiated exposure. As the Harvard Business Review highlights, these “higher fees are unwarranted given that ESG funds often closely mirror ‘vanilla’ funds.”

To rebuild trust, we need to refocus ESG on measurable impact. Clearer frameworks and metrics are needed to help make emissions reporting more standardized and comparable. For example, the Greenhouse Gas Protocol offers widely used standards for measuring and managing emissions. The field also needs qualified sustainability professionals, not just finance experts. Deloitte notes that interdisciplinary expertise ensures ESG factors are assessed comprehensively. This can be crucial to meaningfully integrating ESG into corporate strategy and investor decision-making.

Currently, ESG investing isn’t working optimally, but that doesn’t mean we should give up on it. At its worst, it’s greenwashed PR that offers feel-good optics for investors, but at its best, it’s a way to think beyond quarterly earnings and encourage business to serve the long-term public good. The difference lies in how seriously we treat measurement, transparency and accountability. 

Financial markets can’t fix the environmental crisis alone. But if ESG is done right, it can support climate-conscious policies by investing in a more sustainable economy and world.