In 2021, ESG assets amounted to more than $2.7 trillion; 81% were in European based funds, and 13% in US based funds. In the fourth quarter of 2021 alone, $143 billion in new capital flowed into these ESG funds. Not only have these investments performed poorly in financial terms, ESG funds don’t seem to deliver better ESG performance, either.
The bottom line (pun intended) is that companies that publicly embrace ESG goals sacrifice financial returns and don’t gain much at all to honor ESG interests.
Environmental, social, and governance (ESG) investing allows individuals to invest money with companies that have a mission to improve the world. In their required public disclosures, registered ESG funds describe their investment objective, the investment approach fund managers will take in seeking to achieve those objectives, and the risks that may affect their ability to meet these combined objectives — all the financial while keeping a balance of benefit alongside ESG principles.
Driven by marketing claims that ESG is a way for investors to align their money with their values, it’s now the fastest growing sector of financial services.
Don’t Look at the Man behind the Curtain
“Sustainable funds have the potential to outperform non-sustainable funds. Environmental, Social, and Governance funds have proven resilient in the face of change.” — iShares
“Responsible investing drives better outcomes for investors, our communities, and the planet and is an integral part of our process.” — Nuveen, a TIAA company
“Discover funds that reflect what matters most to you. Explore how ESG funds can play a valuable role in your portfolio.” — Vanguard
The list goes on and on. Dozens of financial firms offer ESG funds for interested investors.
In the US, 65 funds have been repackaged into ESG funds since the beginning of 2019, according to Morningstar. Funds that were struggling to attract inflows changed their names and prospectuses to appeal to sustainability-oriented investors, said Jon Hale, director of sustainability research for the Americas at Sustainalytics, a Morningstar company.
Last year I worked diligently with a financial advisor to move some money to ESG funds. As the planner and I chatted in a get-to-know-you introduction, it was clear that I was a green investor — awaiting the arrival of a Tesla Model Y, no red meat since 1980, sharing stories of the outdoors. So, when I checked out the ESG Aware stocks, I was floored. Exxon Mobil. Chevron. ConocoPhillips. Hess. Valero. I was flabbergasted. I couldn’t believe I was paying for this kind of financial advice.
I guess I’m not alone.
What do you think happened when researchers compared to the ESG record of US companies in 147 ESG fund portfolios and that of US companies in 2,428 non-ESG portfolios? Companies in the ESG portfolios, as summarized by a 2022 issue of Harvard Business Review:
- had worse compliance record for both labor and environmental rules
- did not improve compliance with labor or environmental regulations
Why is this? Evidence derived from combined research at the University of South Carolina and the University of Northern Iowa explains that companies publicly embrace ESG as a cover for poor business performance. As earnings fall short of expectations, companies are more likely to cite stakeholder-focused objectives in their public communications around earnings announcements, so that the push for stakeholder-focused objectives provides managers with a convenient excuse that reduces accountability for poor firm performance.
Columbia Business School data support those findings.
- Relative to other funds offered by the same asset managers in the same years, ESG funds hold stocks that are more likely to voluntarily disclose carbon emissions performance but also stocks with higher carbon emissions per unit of revenue.
- ESG funds also hold portfolio firms with higher average ESG scores.
- ESG scores are correlated with the quantity of voluntary ESG-related disclosures but not with firms’ compliance records or actual levels of carbon emissions.
- ESG funds appear to underperform financially relative to other funds within the same asset manager and year and charge higher fees.
- Socially responsible funds do not appear to follow through on proclamations of concerns for stakeholders.
The veneer of corporate social responsibility is good for business. But it’s seeming less and less as if it’s good for green investors’ vision of a sustainable world.
Lawyers & Regulators Chime in on ESG Integrity
A fundamental flaw in ESG reporting is that the data underpinning ESG ratings relies predominantly on company self-reporting and public sources. The US Securities and Exchange Commission securities is preparing rules that would specify disclosures to be made by investment funds that have terms such as “ESG,” “sustainable,” or “low-carbon” in their names, according to the Financial Times. The rules are expected to require information about:
- how ESG funds are marketed
- how ESG is incorporated into investing
- how these funds get votes at companies’ annual meetings
“There is currently a wide range of what asset managers might mean by certain terms and what criteria they might use,” Gary Gensler, SEC chair, said in March. “It is easy to tell if milk is fat free. It might be time to make it easier to tell whether a fund is really what they say they are.”
Some companies have already become targeted of ESG criticism.
A real shocker happened this month when analysts at S&P Dow Jones Indices booted Tesla from its ESG index, saying that Tesla unquestioningly was high on “E” impact but unsuitable due to alleged safety and labor intransigence.
The SEC recently announced a $1.5 million legal settlement against BNY Mellon’s investment advisor division over claims of misstating and omitting information about ESG criteria for mutual funds it managed.
In March, the SEC released guidelines that would require all publicly traded companies to disclose their greenhouse gas (GHG) emissions and the climate risks they face. The need to report GHG emissions in a standardized way represents an overhaul of corporate disclosure rules such as the US hasn’t seen in more than a decade.
Harvard Law notes that the dramatic growth of the ESG funds sector has “predictably attracted the attention of regulators, commentators, and the private plaintiffs’ bar.” A number of actions asserting green washing claims have emerged with focus on operating companies, including corporations in the oil and gas, mining, and consumer goods sectors, saying they are making misleading claims about the climate friendliness of their operations or the products they manufacture.
Voices beyond Wall Street are emerging about increased need for ESG fund clarity. The Stop #ESGreenwashing campaign, for example, looks to end false labeling and ensures ESG ratings and the investment products tied to them are aligned with international human rights standards.
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