Do ESG funds perform better or worse?
A study from The Journal of Finance found that out of a pool of 20,000 mutual funds with $8 trillion in assets, those rated highly for ESG factors did not outperform those rated poorly. There are many possible reasons for this.
Some studies suggest that companies with high ESG scores tend to outperform the market, while others indicate no significant difference. The relationship between ESG factors and stock performance may vary based on the time horizon, sector, and region.
Funds that invest using environmental, social, and governance, or ESG, criteria underperformed for a second consecutive year. According to data from Morningstar Direct, sustainable U.S. equity funds were up an average 21.6%, including dividends, through Dec.
For example, companies that integrate ESG principles into their strategies tend to attract a wider range of investors who prioritize sustainability and social responsibility. This can lead to increased capital flow and enhanced financial performance.
However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.
The category started to fall out of favor in 2022 as conventional energy prices soared. Political backlash against ESG led by Republican politicians in the United States, as well as suspicions of greenwashing involving claims that are not substantiated, have also tarnished the luster of ESG funds.
Critics portrayed ESG investing as primarily motivated by political concerns and a potential drag on returns. Additionally, some critics have raised concerns about the complexity and reliability of ESG metrics.
Critics say ESG investments allocate money based on political agendas, such as a drive against climate change, rather than on earning the best returns for savers.
Republican politicians have criticized ESG because they say they consider it an effort to use financial tools for the purpose of advancing liberal political goals.
The core criticisms from the investing community contend that ESG is just a fad and that corporate sustainability reports are a weak metric for assessing actual risks. Some ESG-centric investors argue that the sector should focus more on environmental factors and less on social and governance.
Do investors really care about ESG?
Key Takeaways. Retail investors do care a lot about the ESG-related activities of the firms they invest in, but only to the extent that they impact firm performance, independent of ESG performance.
ESG does not really provide a positive risk premium, but rather a negative risk premium, once the performance is explained by the various risk factors and investment sectors. However, ESG can generate positive returns in certain conditions, using ESG momentum.
The analysis revealed that 58% of the papers found positive relationship between ESG and financial performance, 8% negative relationship, 13% no relationship, and 21% mixed results. They conclude that, while majority is positive, the results indicate ongoing disagreement on the issue.
What the critics are saying: The claim that ESG investing can change corporate behaviour and sustainability outcomes for the better is an overreach. Companies selectively provide data to make themselves look more sustainable than they really are.
ESG Investing is Typically Less Profitable
As mentioned above, highly-rated ESG companies tend to be less profitable than lower-rated companies.
Though there are ongoing academic and policy debates about the relative influence of these causes and the degree to which they feed into each other, there is precious little economic evidence to suggest that corporate and investor-led ESG strategies have been a major factor driving inflation at this point in time.
Although financial industry groups claim that one-third of all investment assets are already sustainable, our research shows most ESG investing actually does not create any meaningful sustainability impact.
ESG funds have had about the same amount of risk as their peers. When it comes to the risk of an investment portfolio like a mutual fund, one common measure is the standard deviation of returns. The higher the standard deviation, the bigger the swings the fund has experienced, both up and down.
Musk himself became a vocal critic of ESG ever since Tesla was first booted from the S&P 500's sustainability index a year ago. After Fortune reported some two weeks later about allegations over fraudulent ESG investing by Deutsche Bank, Musk claimed all ESG lists were suddenly fraudulent.
In December 2022, Florida announced that it was taking $2 billion out of the management of BlackRock, the world's largest asset manager (and biggest lightning rod for ESG criticism). This was the largest such divestment thus far. These attacks have been coordinated.
Is BlackRock an ESG?
The firms' strong support of ESG investing in recent years has led some financial advisory firms and a segment of the public to question whether financial institutions should concentrate on financial performance rather than other considerations. BlackRock and Vanguard have a reputation for backing ESG initiatives.
From a look at the headlines, it would be easy to conclude that ESG practices—short for environmental, social, and governance—are on the way out. Political backlash from right-wing Republicans in the U.S. has left many big financial institutions reluctant to talk about their ESG policies.
The first group to coin the phrase ESG was the United Nations Environment Programme Initiative in the Freshfields Report in October 2005.
Vanguard currently offers several exclusionary ESG products across equity and fixed income that help investors to avoid certain ESG risks.
Over the next few days we will explore new reporting metrics and standards, and targets gathered from across companies and industries that you can utilize to produce a consolidated ESG framework that embeds LGBTQ+-inclusive diversity, equity, and inclusion.
