The Wall Street Journal has published a symposium of ten brief essays addressing the question, “Where Will ESG Investing Be in Five Years?” The authors are split between academics specializing in finance and various sorts of investment professionals. They express, as the symposium’s subtitle notes, “some very different views”.
Two of the contributors caught my eye, because they are well known figures in the pension commentariat: Olivia S. Mitchell, a Wharton School professor and director of the Pension Research Council, and Alicia H. Munnell, Peter F. Drucker professor of management sciences at the Carroll School of Management (Boston College) and director of the Center for Retirement Research. Both, I’ll note at the outset, are political liberals, but “everyone is conservative about what he [she in this instance] knows best”.
Professor Munnell is the more emphatic:
Where will ESG investing be in five years? Dead, I hope.
In my view, ESG funds are a marketing ploy by financial-services firms to repackage actively managed investments – which were becoming increasingly less appealing – in a trendy wrapper. They are expensive and accomplish nothing. And they divert people’s attention from the hard work that needs to be done.
Proponents argue that integrating ESG factors into existing methods of financial analysis allows investors to reduce risk and earn higher returns, while supporting socially beneficial practices and outcomes. But it isn’t clear that ESG money is even reaching the right targets. The Securities and Exchange Commission has started to crack down on greenwashing – the claim that investments will save the world with little evidence to support it.
An even more pernicious aspect of social investing through ESG funds is that it allows people to think that they’re really solving an important world problem when, in fact, they are doing nothing. It’s delusional to think that business can lead the way on fighting climate change or racism. The only people gaining from ESG investments are financial-services firms that monitor corporate promises in exchange for higher fees.
Professor Mitchell, without calling for ESG’s demise, says that the growth of ESG investment faces “several big obstacles” and is “skeptical” that they can be overcome. The obstacles include:
- the lack of any “coherent and unique definition of what ESG involves, making it impossible for investment professionals as well as everyday investors to identify whether these approaches are actually being carried out”;
- the consequent inability “to show that ESG helps (or hurts) invest performance”;
- the general absence of any correlation of “ESG ratings developed by corporate ratings firms . . . with each other or with firm performance”; and
- the very high expense ratios of ESG funds.
I have provided links to supporting studies cited by Professor Mitchell under “Further Reading”. She concludes by drawing attention to what seems to me to be one of the glaring weaknesses of ESG: that it puts three very different eggs into a single basket.
A better system would delink the environmental, the sustainable and the governance criteria, require disclosure of firms’ policies along each dimension, and require them to lay out their efforts to change.
The ESG-positive contributors don’t all ignore the murkiness of the concept. Some of them want more clarity, but for a reason that suggests a fundamental misunderstanding of the difference between investments and political contributions. Derek Tharp, a professor of finance and, perhaps more pertinently, founder of a wealth management firm, writes:
A major limitation of ESG funds is that it is hard to find a fund that perfectly aligns with one’s own values. Even two individuals who agree on the broader focus of a fund – say, protecting the environment – may still disagree on the best way to implement that. Nuclear energy is a popular example that splits environmental advocates. There is no neutral resolution to this divide, so a fund will inevitably need to take a stance on how to handle nuclear energy within the portfolio – and that will inevitably leave some potential investors in disagreement with the fund’s stance.
We may wish that companies of whose goods and services we approve will prosper, but that doesn’t mean that they will. If all users of word processing software or Internet browsers shared my own preferences, WordPerfect and Opera would dominate their markets, and Mr. Gates’s toy products would occupy minor niches, but my velleities would be a poor guide to increasing the value of my portfolio.
A final note: It’s striking that in these essays, the academics for the most part write clearly, while the investment professionals churn out jargon-heavy word salads, such as this from “Manisha Thakor, founder of financial well-being consultancy MoneyZen”:
I see ESG investing growing in effectiveness as it becomes knitted into the fabric of the global business ecosystem. At the board-of-directors level, ESG will become a clearly delineated component of existing subcommittees or a distinct subcommittee on its own. Institutional analysts and portfolio managers, irrespective of investment strategy and asset class, will discuss why they do, or don’t, incorporate ESG factors into their portfolio-construction process in the same manner as discussing whether they focus on P/E ratios and debt ratings. Institutional clients such as pensions, endowments, foundations and their consultants will consider their stance on ESG to be as vital a component of their investment-policy statements as asset allocation.
If your financial advisor starts talking to you like that, you’re probably better off with meme stocks and RobinHood.
Further Reading: David F. Larcker, Brian Tayan and Edward M. Watts, “Seven Myths of ESG”
Florian Berg, Julian F Kölbel, Anna Pavlova and Roberto Rigobon, “ESG Confusion and Stock Returns: Tackling the Problem of Noise”
Rebecca Moore, “Morningstar Finds ESG Funds Are More Expensive Than Conventional Funds”
Matt Wirz, “Green Junk Bonds May Not Deliver Green Results”