Why do ESG stocks outperform?
Outperformance of ESG investing can be shown to be largely driven by sector/factor biases, and a negative alpha is obtained after accounting/ correcting for these biases. ESG outperformance can possibly be generated by filtering on changes in ESG scores, suggesting the existence of an ESG momentum effect.
Theory of ESG Stocks Outperforming the Market
These companies engage in renewable and sustainable practices or try to promote social responsibility. Prioritizing these issues results in a company that pays more attention to its operations at all levels and is governed by more sustainable principles.
ESG funds have similarities to other funds
While the results from these time periods have been generally encouraging for ESG funds as a whole, we don't see convincing evidence that ESG funds are reliably better than non-ESG funds.
People are increasingly drawn to ESG investments for many reasons, from ethical considerations to financial prudence. Companies with robust environmental, social, and governance practices are better equipped to navigate regulatory changes, reputational risks, and operational challenges.
Do well by doing good? Don't count on it. 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.
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. They say ESG is just the latest example of the world trying to get “woke.”
Vanguard currently offers several exclusionary ESG products across equity and fixed income that help investors to avoid certain ESG risks.
About two-thirds of privately-owned companies have ESG initiatives in place, according to the NAVEX survey. 89 percent of investors consider ESG issues in some form as part of their investment approach, according to a 2022 study by asset management firm Capital Group.
| Pros | Cons |
|---|---|
| Can help investors diversify their portfolio | ESG funds may carry higher than average expense ratios |
| May reduce portfolio risk | ESG investing is still a fairly new concept and there isn't a ton of reporting on performance |
Is ESG causing inflation?
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.
It polarises because there are two schools of thought at play: the first suggests that adopting ESG or sustainable practices in business is a fundamentally inflationary act. The second school of thought argues that doing nothing to address issues such as climate change is, ultimately, even more inflationary.
In the '60s, ESG became much more mainstream, around the same time as the evolution of the mutual fund industry, the civil rights movement, and the protesting and boycotting of companies involved in or in support of the Vietnam War.
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 concept, he said, had become a fad without much substance or meaning. ESG investing took off and became a buzzword — the “artificial intelligence of six years ago,” said Jenkins. “Every single conversation was about ESG, and there's a whole industry built around this,” he said.
Coupled with the fact that ESG ratings are primarily self-reported, this pattern has given rise to a system where companies can superficially endorse sustainable practices, indulging in what is known as greenwashing, without having to demonstrate concrete results or genuine commitment to environmental responsibility.
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.
BlackRock has sought to position itself as an industry leader in environmental, social, and corporate governance (ESG). It has been criticized for investing in companies that are involved in fossil fuels, the arms industry, the People's Liberation Army and human rights violations in China.
Some opponents also believe that ESG investing is politically motivated and could lead to biased investment decisions.” In a line used by proponents, those in opposition to the ESG movement also believe there is substantial support behind them.
Who is behind ESG?
The first group to coin the phrase ESG was the United Nations Environment Programme Initiative in the Freshfields Report in October 2005.
ESG's increasing centrality to the business agenda has resulted in an “anti-woke” backlash. The furore highlights the need to double-down on concrete ESG commitments and action. Greater clarity in ESG regulation may help convert the doubters.
Schwab is committed to ESG through sustainable real estate practices, responsible workflows, and investment stewardship.
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.
Our commitment to proprietary ESG research reflects our steadfast focus on helping our customers and clients meet their financial objectives and sustainability goals. Fidelity's core principles sit at the heart of our investing and stewardship activities.
