Stocks chosen for their adherence to environmental, social and governance (ESG) metrics have been underperforming the wider equity market. ETFs (exchange-traded funds) focused on buying ESG stocks are performing at their worst levels since the summer of 2019, and short sellers are cashing-in.
ESG investing has long been purported as a viable strategy to encourage corporations to move from irresponsible, short-term behaviour to long-term sustainability. Put simply, ESG investing has investors only supporting companies that meet certain environmental, social and governance measurements. By directing capital to these companies only, it is hoped that pressure will be put on non-complying firms to change their ways in order to attract capital.
A close look at ESG funds reveal many problems, however. These funds are overwhelmingly reliant on technology and e-commerce stocks, and so their success largely depends on the performance of quite a limited number of companies. This also raises the question: with such large and record amounts of capital being invested, how much pressure can ESG funds truly create on companies who do not meet ESG goals? In fact, there is such an abundance of capital that some is being specifically directed to bet against ESG investors.
Many make the claim that ESG investing is just another form of greenwashing. A look at the iShares ESG Aware fund, which represents US$8.9 billion in capital, is invested in the likes of Apple and Microsoft – companies that have faced much criticism for their environmental impact and other corporate misadventures. When ESG funds offer little support to companies that can create true change, such as emerging companies in the renewable energy space, their effectiveness must be questioned. Increasingly the market is seeing these funds invest in companies that appear to do no wrong, but hardly direct their capital to new firms that seek to change the status quo. While investing in these firms is certainly a risk, there can be no progress without such a financial gamble.
When an ESG fund’s top holding is Amazon, Alibaba, Microsoft or Apple, investors need to be wary about the effect their capital is having. All of these companies are inherently supported by infrastructures that many would not consider ESG-friendly. 2020 so far has seen nearly triple the amount of ESG investment as compared to 2019, with US$22 billion so far poured into ESG funds. Much of this capital is finding its way to firms like Apple and other technology giants.
The moral of the story is that if investors want to make a meaningful impact, they must look beyond the name of the fund they are investing in – merely having “ESG” in the fund name can be misleading for investors. In any case, investing may not be the strongest approach for change due to the incredible abundance of capital that today’s capital markets have access to. This is the case even for some of the largest asset managers. Despite BlackRock (US$6.84 trillion assets under management) publicly stating, “We will be disposed to vote against management and board directors that do not make progress on disclosures”, a look at reality shows that BlackRock voted for only 10% of climate-related shareholder resolutions that came its way. True power to affect change comes from consumers’ spending – if the world wants to see less of a negative impact stemming from a particular corporation, stop feeding into their bottom line by purchasing their products and services.