Some investment funds that make us feel good to invest in don’t always do good, even when they promise to.
And I don’t just mean do good in the sense of investment performance.
I mean doing good in the world.
The desire to invest in companies that are ethical is a principled desire. We may genuinely want our portfolio to line up with our beliefs and values.
ESG funds were considered a way in which investors might do this. Our regulator defines it this way: “‘ESG’ stands for environmental, social, and governance. ESG investing is a way of investing in companies based on their commitment to one or more ESG factors. It is often also called sustainable investing, socially responsible investing, and impact investing.”1
These kinds of funds filter for companies that line up with anything from “green” values to “biblical” values. They serve as a way to invest in companies that correlate with one’s conscience.
Not bad, right?
Marketers know the human heart well. Like it or not, capitalism is happy to prey on these kinds of desires. Come to find out “green” investing attracts “green” dollars too.
One Bloomberg article from a year ago noted: “…(ESG) assets are set to balloon to $50 trillion by 2025 from about $35 trillion, according to estimates from Bloomberg Intelligence. The growth has been spurred by record-breaking fund inflows amid concerns about climate change and other societal issues.”2
Let’s go even deeper and look at another angle to the desire for socially good investments. Sometimes we want to invest in these kinds of companiesto appear good to those around us also.
I know. Not you.
C’mon though. A teeny bit?
The motivation isn’t just an intrinsic one to do the right thing, but an extrinsic one to be seen as doing the right thing. Behavioral economists call this “image motivation.” One writer says it like this:
“..our social reputations are important to us, particularly in the context of generosity and charity, and they illustrate a social type of extrinsic motivation: image motivation. Some of our choices reflect the fact that we want to boost our reputations and improve our image.”3
Here is the bad news of ESG investing: The evidence shows that not only do many funds in that category not perform that well in investment return, but many also don’t do what they claim to be doing in the world.
Sanjay Bhagat, a Provost Professor Finance at the University of Colorado, in an article for Harvard Business Review, unpacks this:
“To begin with, ESG funds certainly perform poorly in financial terms. In a recent Journal of Finance paper, University of Chicago researchers analyzed the Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. Although the highest rated funds in terms of sustainability certainly attracted more capital than the lowest rated funds, none of the high sustainability funds outperformed any of the lowest rated funds.
That result might be expected, and it is possible that investors would be happy to sacrifice financial returns in exchange for better ESG performance. Unfortunately, ESG funds don’t seem to deliver better ESG performance either.
Researchers at Columbia University and London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance record for both labor and environmental rules. They also found that companies added to ESG portfolios did not subsequently improve compliance with labor or environmental regulations.”4
Yes, you should invest ethically. You should also know that financial firms know many of you want to, and the fact is they can take advantage of this knowledge.
No, this does not necessarily mean that you must get rid of all these kinds of funds in your portfolio. We don’t give investment advice through blogs. We customize advice based on knowing our clients.
But let’s face it. Funds marketed as good for the world may not only be weighing on the investment return of your portfolio, but they may also be hypocritical too.
- Behavioural Economics: A Very Short Introduction, p. 13