Why renewable energy indexes can still fail at ESG

“But even a sustainability-oriented portfolio can carry hidden ESG risk,” the report said.

Morningstar said the Global Markets Renewable Energy Index, the most inclusive member of its Renewable Energy suite of indexes, has a carbon intensity score of 1,719.47, almost a whole order of magnitude higher than its broad equity market equivalent that has a 183.78 carbon intensity score. From an overall ESG perspective, the renewable energy benchmark also carried a significantly larger amount of risk than the broad equity market.

“[M]any companies are involved in both fossil fuels and green solutions,” the report said, noting that a large subgroup of utilities companies in the index includes carbon-intensive companies such as China Power, RWE, and AES. Some companies focused on climate-friendly products and services, such as Sunrun and Nankai Electric Railway, can also nonetheless have carbon-intensive operations, it said.

Morningstar added that Tesla, a prominent member of its renewable energy indexes, also carries ESG-related risks that potentially more than offset the credit it gets for producing emissions-free electric cars. Its factory workforce, the report said, constitute a labour-relations challenge, while issues in its autonomous driving offerings raise questions about product governance.

“Corporate governance is also a concern,” Morningstar added, noting how CEO Elon Musk has made problematic public statements and used his 20% equity stake as collateral for personal loans. Other potential ESG pitfalls come from patent litigation and regulation requiring a separation between automakers and dealers.