A new report from CIBC Capital Markets analysts says funds focused on environmental, social and governance (ESG) issues may be missing the mark by putting too much emphasis on the “E” and not enough on the “S” or the “G”.

In a note to clients on Monday, CIBC’s equity strategy team said the relative ease of measuring carbon emissions compared to the complexity of parsing through social and governance variables has led to an over-emphasis on environmental factors. That could warrant a rethink of ESG investment strategies.

“In evaluating ESG risk, however, carbon should not be the only variable to consider. Unfortunately, this doesn’t appear to be the case. Tesla is one of the most owned equities within the ESG universe given its environmental performance, yet the company certainly leaves room for improvement on both governance and social issues (Elon Musk is quite anti-union),” they said.

CIBC noted that the focus on carbon emissions has led ESG funds to make the “shocking” decision to load up on Russian energy firms.

“In the most shocking example we have come across to date, the ESG fund universe owned twice as much Russian oil and gas as Canadian oil and gas at the end of last year,” they said.

“Clearly, the concept of aligning investments with the values and ethics of responsible corporate citizens was significantly outweighed by simple, backwards-looking carbon metrics.”

CIBC noted that the big four Russian energy companies – NK Lukoil, Novatek, Gazprom and NK Rosneft – accounted for about 0.2 per cent of the global ESG holdings, about twice that of Enbridge Inc., TC Energy Corp., Suncor Energy Inc. and Canadian Natural Resources Ltd.

The CIBC team said that while countries like Russia and Saudi Arabia can plausibly produce lower-carbon intensive oil, simply going by that metric ignores serious social transgressions in those countries.

“Russia and Saudi Arabia may well emit less CO2 per produced barrel of oil equivalent than some North American firms, but they also invariably have less robust social and governance oversight,” they said. 

“This says nothing of the reality many of their energy entities are de-facto state controlled and often aligned (read: weaponized) with foreign policy objectives – many of which will be an afront to mainstream ESG investors. To be blunt, the importance of Social and Governance within Energy should not be looked over.”

The CIBC team said investors are increasingly getting wise to the challenges of ESG investing, with global flows into ESG funds down more than 50 per cent through the first two months of this year.