ESG funds – green sustainable investing or a marketing gimic?

In recent months I have been looking at all aspects of my life to assess where I can lighten my ecological footprint and, within my personal sphere of influence, positively encourage global warming mitigation action.

Naturally for someone interested in personal finance, the question arises whether there are ways to invest in companies that have more progressive stances on the environment and, likewise, avoid certain firms or industries which don’t.

One approach that is becoming increasingly popular is ESG investing. ESG refers to Environmental, Social and Governance, three key factors in measuring the sustainability and ethical impact of an investment in a particular company. The concept picks up environmental concerns (eg. climate change and sustainability), social concerns (eg. diversity, human rights, consumer protection and animal welfare) and corporate governance (eg. executive pay, employee relations and compensation). All good things in my mind, and aligned with my values.

Like anything though, it is important to look beyond the surface and unfortunately ESG doesn’t necessarily mean as green, sustainable or ethical as I assumed. Digging a little deeper has me questioning whether ESG funds are materially different from other investment options, especially within an index fund. At a more fundamental level, I’m also questioning whether attempting to invest in sustainable companies makes sense or if there better ways to allocate my money and time.

The Good: Positive Returns

“Doing the right thing” doesn’t always correlate with financial reward, and it would be logical to think that excluding some investment options may harm returns.

However, according to a recent Morningstar study, 73% of their ESG indexes outperformed their non-ESG equivalents, since inception. They also suggest that ESG indexes favor companies with healthier balance sheets, stronger competitive advantages and lower volatility than their mainstream counterparts. Underpinning this seems to be a longer term and more balanced perspective than companies chasing short term returns.

So on the surface it looks like socially responsible investing doesn’t mean that you need to compromise on returns. In fact you may get better and more sustainable returns over the long run.

The Bad: Look beyond the label

Like other areas in life, if you are looking to invest in funds more aligned with your values, it pays to look beyond the name of the fund.

According to a recent Wall St Journal article, eight of the top 10 biggest US ESG funds are still invested in oil and gas companies.

The rationale (excuse?) is that they still need to deliver a similar risk profile and returns to broad market indexes. As a result they can’t exclude a particular sector entirely, and instead invest in the least bad companies within a particular sector.

I guess this kind of makes sense. But I do admit that I was suprised to see ESG funds investing in fossil fuels.

A coalition of environmental groups recently criticized the world’s biggest asset manager, BlackRock, for including in their “green” options coal, oil and gas companies as well those involved in deforestation.

So it is important to look beyond the label and read the disclosures of what you are investing in. How different are some of these ESG funds to standard index funds?

The Ugly? Some ESG funds appear to simply be a marketing gimmick to attract investors

In the same way that terms like “Diet”, “Organic”, “All Natural” and “Green” are often misused and intentionally misleading, the ESG labelling of stocks and index funds feels a bit icky.

Are the fund managers truly attempting to provide consumers with the opportunity to invest in environmentally sustainable companies, or are they simply trying to repackage funds by slapping an ESG name on the prospectus cover?

Unfortunately, there are no standards as to what qualifies for an ESG investment option. Some companies qualify based on stated goals rather than actual progress. Picking the best of the worst in distasteful sectors, to track to the index, is still supporting the bad actors.

Are ESG Funds simply a marketing gimmick to capture the current wave of interest in sustainability and the environment? There seems to be an element of truth to this.

Are there viable alternatives to get competitive investment returns while supporting sustainable companies?

The reason for this blog post was simply to remind people to do their research. It is important to know what you are really buying. Until there are stronger standards, you’ll need to dig a little deeper to understand what the ESG index fund you’re considering investing in is comprised of.

While I was surprised and disappointed to learn ESG funds included sectors like the fossil fuel industry, you could argue that they aren’t any worse than what is on offer in ‘standard” index funds, with many of the same companies included. At least they are excluding the really bad actors. They also appear to be performing well, if not better, than standard non-ESG index funds.

If you can’t stomach this compromise, are there good alternatives for the individual investor? Unfortunately I don’t think there is a clear answer or solution, at least one that I’m aware of, and instead only more questions to ponder:

  • Given the truism that individuals rarely outpeform the index over the long term, is it worth the financial risk to pick individual “sustainable” stocks?
  • As an individual investor, are we really driving change by buying a particular companys’ stock over another? The reality is that my investment dollars are inconsequential to most company balance sheets, and definitely wouldn’t be enough to provide voting rights or other more direct routes of influence. Where I invest won’t change a company’s strategy or behaviour
  • Maybe it is more effective to support a sustainable business model by buying their products/services, donating money or volunteering?
  • Is it better to drop the idea of green investing altogether, and simply look to maximize your investments? You can then give back or support a cause in other ways.

Personal finance is personal. I hope this was helpful in informing your own investment decisions. I admit to not being convinced by ESG funds, but I am also not clear about a better path forward. I’d love to hear your thoughts.

Thanks for reading.

Mr Simple Life

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3 thoughts on “ESG funds – green sustainable investing or a marketing gimic?

  1. My first thought was of the various nonprofits and “carbon-neutral” organizations that look good on paper until one looks beyond the carbon credit purchases. In some cases, there is mission shifting going on behind the scenes, too, and the reason for investing disappears.

    So I think being a conscientious consumer – as you mentioned, buying sustainable products/services – is still the best way to affect change. I also think it’s helpful to be realistic. I have older family members who invested in natural gas companies because it’s better than fuel-oil furnaces and wood-stoves. They also invested in hydrogen-cells developers in hopes that as people recognize the environmental hazards of electric batteries, they will shift the market to an even cleaner fuel.

    Liked by 1 person

    • It’s definitely not clear cut and there is a lot of marketing spin at both the company level and the index funds. The E.U. are apparently working on rules and regulations to stop ‘greenwashing” and define what can be classified as an ESG investment. Like you point out though there will still be lots happening behind the scenes that isn’t obvious or transparent to investors

      Liked by 1 person

  2. Pingback: Stop chasing more and embrace a life of less | Simple Life Compass

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