A Take on ESG Investing

When it comes to our industry, there are so many acronyms it is easy to get lost! Lately, there is one you may have heard that is sweeping fund companies by storm, earning both endorsements and critiques from some big players: ESG investing.

Environmental, Social, and Governance funds (ESG funds) have grown to an impressive $35.3 trillion in assets under management in 2020. In theory, ESG funds hold securities (stocks or bonds) issued by companies that make efforts toward fighting inequality, climate change, or boast a diverse management team. On paper, the mission looks admirable, but it gets a bit more complicated.

ESG investing has received criticism from both the left and the right. Those on the left claim that the style is just greenwashing, a marketing ploy to make ‘dirty’ companies look ‘cleaner.’ They argue that investing in these funds does not lead to any meaningful change and damages the very causes it claims to support. Investing in solely ESG funds may allow people to offload their responsibility to help create a free, clean world.

Some even go as far to state that, in an area the free market has failed, more market cannot be the solution. On the other hand, those on the right, say the idea is anti-free market.

The decision as to which companies are good enough to make it into an ESG fund is made by committees at the investment company responsible for designing the fund, and there really is no consistent or standard measure to what makes a company ‘good’. Many investors understand ESG funds have limitations because of this but see ESG investing as an opportunity to use capitalism for a greater purpose. Some ESG supporters believe you can have your cake and eat it too, and there is some data to support their claim.

In 2020, the S&P Composite 1500 ESG, a US-based ESG index with companies of all sizes, returned 36.4%, only .2% less than its non-ESG counterpart. The same fund over the past three years has returned 18.6%, outperforming the traditional S&P 1500 Composite which returned 17.2% over the same period.

However, the explanation may not be that ‘clean’ companies are better performers. Lots of technology companies earn spots in ESG funds simply because the nature of their business lends itself to a smaller carbon footprint. As a result, ESG funds have benefited from the impressive technology run-up over the past few years. Regardless, the ESG style of investing is so new it’s hard to make any return claim given such a short period.

The ESG investing space is rapidly growing and evolving. The more market share it begins to take up, the more critiques it will likely face, but that is how flaws are realized and improved upon. For some, these funds offer an opportunity to ally with companies who hold similar beliefs. In the right situation, ESG funds may offer investors a vehicle that allows for some control over the companies they invest in.

 

Rachel Buckhoff

Rachel Buckhoff is an Associate Financial Advisor and financial planner with Financial Synergies Wealth Advisors in Houston, TX.

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