When I first started in this business in 1992, socially responsible investors were willing to sacrifice a little return to prevent their money from being invested in alcohol, tobacco or firearms companies. They understood that by limiting the universe of investing these investors should expect less return and less diversification than a portfolio which sought simply to maximize profit. Over the past few years, a new way of thinking has emerged with socially responsible funds being re-labeled, ESG. The acronym stands for Environmental, social and governance. The popularity of these investments exploded in 2021. In that calendar year funds labeled ESG were raking in $8 billion a day! According to Bloomberg, by the year 2025 ESG labeled funds could account for 1/3 of all globally managed assets, totaling $50 trillion. *
One problem with ESG investing is in the definition. Why is Tesla’s ESG rating (as scored by Sustainalytics and MSCI; two leading rating agencies) below those of Pepsi?*. Additionally, the two firms have trouble agreeing with each other. Underlying assumptions, methodologies and data inputs make any objective analysis difficult at best. According to a recent study by Florian Berg, Julian Kobel, and Roberto Rigobon “ESG scores among leading rating agencies correlated only 54% of the time…”*
The new generation ESG funds promise that you can “do well and do good at the same time”. According to Bradford Cornell of UCLA and Aswath Damodaran of NYU, “telling firms that being socially responsible will deliver higher growth, profits and value is false advertising.”
Nineteen attorney generals around the country agree. Led by Arizona AG Mike Brnovich they claim, “Based on the facts currently available to us, BlackRock appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote,” ^. (Blackrock is the largest asset manager in the world and a leader in ESG investing).
So ESG investing might not generate the best possible return for shareholders, but how much does the return suffer? Quite a bit according to a recent study by Cornell and Damodaran. They found, “Over the past five years, global ESG funds have underperformed the broader market by more than 250 basis points per year, an average of 6.3% return compared with a 8.9% return”. To make matters worse, there is little evidence that allocating money to ESG companies has helped society. According to the study, “(Divestiture)…does exactly the opposite of what it intends. Divestiture raises returns for the shareholders who remain invested and removes shareholders who are inclined to fight for corporate reforms.”
So, what is the answer? In a capitalist society it is best to vote with your pocketbook. “The production of goods and services declines when people stop buying them – not when others stop investing in the companies that produce them.”
· Wall Street Journal “ESG Does Neither Much Good nor Very Well” 9/17/2022