Why ESG funds underperform?
Most of the ESG underperformance in 2022 can be attributed to ESG funds' underweight in the traditional energy sector, she noted in the report. “When ESG funds underperformed in 2022, we blamed it on their energy underweight,” said Ma.
Total ESG funds were down 29% in 2022, compared to a 21% drop in non-ESG fund assets, reflecting declines in global stock and bond markets as central banks raised interest rates to reduce inflation, the Ukraine war, and political backlash against the industry.
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.
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.
The poll of 420 investors, covering asset owners and managers, hedge funds and private equity firms, finds that 71 percent view 'inconsistent and incomplete' data as the biggest barrier to ESG investing.
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.
Comparing the MSCI USA Extended ESG Select Index to the S&P 500 Index, the MSCI USA Extended ESG Select Index outperformed the S&P 500 Index in all but one of the last seven years. In 2022, the S&P 500 declined by 19.44%, while the MSCI USA Extended ESG Select Index declined by 21.12%.
In some cases, ESG has outperformed, while in others, it has underperformed. Figuring out whether ESG stocks outperform the broader market is difficult for a few reasons. For one, there isn't a central authority that can decide whether a business follows ESG practices.
A new study examining a decade of data finds portfolios of exchange-traded funds (ETFs) that follow environmental, social, and governance (ESG) investing strategies did not perform any better than standard index funds.
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.
Why is Elon Musk against ESG?
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.
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.
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.
The adoption of ESG principles in investing and corporate decision-making has been met with criticism from various angles. The main issues are around the lack of standardisation and transparency, greenwashing risk, and questions around financial returns and ethical dilution.
ESG funds are experiencing a decrease in new inflows and increased closures due to underperformance and investor withdrawal. Regulatory tightening, greenwashing exposure, and a return to oil and gas investments contribute to the declining appeal of ESG funds.
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.
Like many economic factors, ESG factors exhibit diminishing returns, and trade-offs exist. Some ESG factors, such as employee satisfaction, have diminishing returns to scale but linear costs. Other ESG factors have hump shape relationships and ultimately negative returns.
The first group to coin the phrase ESG was the United Nations Environment Programme Initiative in the Freshfields Report in October 2005.
Activist investors are expected to carry out fewer environmental and social campaigns this year after the strategy proved less lucrative than other shareholder agendas, according to business consulting firm Alvarez & Marsal Inc.
In recent years, Telsa has been accused of allowing racial discrimination and poor working conditions at its Fremont Factory, as well as lacking a low carbon strategy and codes of business conduct. The claims are so troubling that Tesla was removed from the widely accepted S&P 500 ESG Index.
Are big ESG funds doing worse than the S&P 500?
The average large-cap stock ESG fund had lost nearly 20% in 2022 through Dec. 21, according to Morningstar. That's about 2.4 percentage points worse than the drop in the S&P 500 Index , including dividends. S&P Dow Jones Indices says its S&P 500 ESG Index is down 18.5%, also including dividends.
For quite some time, ESG (Environmental, Social, and Governance) investing has been all the rage. Although the concept has been around since the 1960's, institutional interest in ESG really began to accelerate at the end of the 2010's, and net inflows into ESG and sustainable funds peaked in 2021 at USD $649 billion.
Vanguard currently offers several exclusionary ESG products across equity and fixed income that help investors to avoid certain ESG risks.
Overall, the survey found that 85% of investors think ESG leads to “better returns, resilient portfolios and enhanced fundamental analysis.” Among executives surveyed, 84% said ESG helps them “shape a more robust corporate strategy,” according to Adeline Diab, BI's director of ESG strategy and research.
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.
