Reasons To Be Careful With ESG Investing
At the end of 2021, ‘sustainable’ funds publicly setting environmental, social and governance (ESG) objectives came in at more than $2.7 trillion. There is an astonishing amount of cashflow in these funds, but many investors are not faring as well as they had hoped.
ESG funds don’t tend to perform the best. Those centred around sustainability are becoming increasingly popular, but those with a higher sustainability rating rarely outperform those with lower ratings. Of course, many may be willing to take that hit in the knowledge that they are investing in better ESG performance, but many don’t seem to deliver this either.
Research from Columbia University and the London School of Economics compared the ESG records of a large number of US companies in ESG and non-ESG portfolios. The results indicated that compliance records for labour and environmental rules often fell short in ESG companies.
This has been backed up by findings from a recent European Corporate Governance Institute paper.
Why such poor performance from ESG funds?
Part of the reasons may be that a focus on ESG is somewhat redundant.
Corporate managers in competitive markets try to maximise their long-term shareholder value, so they are already paying attention to interests like employees, customers and the environment.
It may also be that some companies publicly commit to ESG to cover up their poor business performance.
There is some evidence of this that indicated some managers who underperform against earnings expectations choose to publicly talk about their ESG focus. Conversely, companies that exceed expectations almost never talk about ESG.
What we can interpret from this is that funds investing in companies that publicly embrace ESG may sacrifice financial returns.
Even if you are an investor willing to take this hit if it means furthering ESG interests, there is strong evidence that this objective is not necessarily met by investing in companies that purport to represent ESG interests.
This is not to say that ESG is not an important consideration for the modern investor. It just means one should do their research more thoroughly before placing their capital with companies that may not deliver on their promises.