Yes.
Well, OK, we might need a little more explanation than that. Environmental, social and governance investing, ESG, is absolutely, wholly, worth it in one sense, the moral one. As a way to make money well, not so much. Which means that if you’re looking to invest while keeping your soul pure then ESG might well be for you. If the aim is to roll in cash like Scrooge McDuck then perhaps not.
But whose ethics drive ESG investing?
Of course, most of us are a little more complicated than that. We’d not invest in slavery, or child sex, however profitable it was. But we might also not share current elite opinions over, say, gender equity in the boardroom or the selling of tobacco. Fortunately, we still live in a market system so each and every legal ethical position is still catered to.
But leaving aside that match up with personal ethics a grand claim from the promoters of ESG is that it actually makes the investor money. There the evidence is more mixed. In fact, the evidence is mixed enough that probably it doesn’t, over time.
The claim is that consumers care deeply about these varied things. Therefore, companies that meet those ethical standards will gain more custom. They’re more profitable that is. And that’s the bit that seems a bit sticky. We don’t, in fact, see grand proof that following the ragbag of currently fashionable ideas does indeed boost turnover and therefore profit.
But does ESG investing work in a money sense?
Well, OK, but does it boost asset values? There the evidence in favour is stronger. Not, not really, because ESG is better in this investing sense. But because there’s some $18 trillion of ESG managed funds out there. $18 trillion’s, you know, a lot. And there aren’t that many large companies out there. Small companies tend not to bother with these fads – if it is indeed a fad – and $18 trillion is therefore a substantial portion of the relevant funds under management. So, just the sheer weight of money being allocated according to ESG principles pushes up the asset values of ESG investments.
Which is great – but only if you own those before they get ESG tagged. This is only ever so slightly complicated. If ESG conforming companies are more profitable then they will outperform over time. But as above, we’ve no real evidence they are. On the other hand, if the weight of money argument is the only real ESG effect then it only applies to that new dawn of a stock being ESG compliant and therefore invested in.
In fact, after that first boost, the effect reverse. The share, bond, whatever, is now more expensive because of the ESG compliance. OK – that’s the same thing as saying that ESG raises asset prices. But that also – by definition – means that it has a lower yield. Which, if future performance were greater, wouldn’t matter. But if future performance is unrelated then the total return from something that is already ESG rated is lower.
ESG depends upon what we call value or return in investing
Which does make this all rather complicated. If the belief is that doing right is good business – and that that’s true – then ESG is worth it. If it’s only the weight of money argument, then it isn’t – except in those companies that are newly ESG compliant.
There is one more level here though. We’ve looked before at entirely non-ESG things like tobacco stocks and given investor ethics that may, or may not, be an acceptable outperformance. But now think of management fees. Nothing comes for free of course. So, investing through a fund comes with fees. An index fund, absolutely no decision making at all, might cost 0.07, 0.09% annually, something like that. An actively managed fund might be about 1%. There’s not a huge amount of evidence that the much higher management fee results in greater investor return to be honest. Much to most of the higher return from active management seems to be eaten by the management. With ESG funds a 2% fee isn’t unusual. At which point there’s very little evidence indeed that the investor return improves.
In the end ESG depends – again – on whose values?
Now, of course, it’s difficult – the extent of not right to even try – to be categorical about fund returns. Some do very well indeed for their investors, others not so much. But on average, over long periods of time, low load index funds seem to do as well as managed funds – to be mild about it. And ESG funds, with their near double the fees, are unlikely to do better than that.
At which point a summation. A corporation becoming ESG compliant might well see outperformance as it benefits from that $18 trillion wall of money hitting it. Other than that, ESG investing is really not about investor wallets at all, it’s about investor morals and hearts. At which point, well, what are we actually investing for? Money or what? Of course, there’re some things we’ll not invest in for the sake of being able to sleep at night but whether that’s the same set of things current fashion says are very naughty, well, up to us really.
