The ESG Conundrum

It appears that interest in investing based on environmental, social and governance (ESG) factors is growing. The question is, how to go about it? To start with, how can investors themselves determine which companies live up to ESG standards?  Currently, they have little alternative to relying on outside raters.  However, ESG ratings vary substantially depending on who is doing the rating.  Investing in a fund that purports to be ESG compliant, also presents problems.  See our blogs of April 14, 2021, titled, “How Many Raisins in a Box of Raisin Bran?”, October 1, 2021, titled “How Green is Green?” and, May 25, 2022, titled, “ESG?  Who Decides?”, that conclude that ESG is what the fund manager says it is.

The increasing interest on the part of investors has led to greater scrutiny and efforts to improve definitions.  This is probably a good thing.

However, it still leaves the elephant in the room, performance.  Will an ESG focused portfolio strategy affect an investors returns? Can ESG focused funds, typically with higher fees, match more traditional portfolio strategies?  Will ESG fund managers have to acknowledge that there may be some trade-off between ESG and financial returns?  As past performance is not an indicator of future results, investors are going to have to make their own decisions.  This won’t be easy.  Consider actual results for three, large investment portfolios for the first 10 months of 2022:  SPX, tracks the S&P 500 index, down 21%, USGU, purports to track an index composed of US companies with positive ESG characteristics, down 23%, and, XLE, that seeks to provide an effective representation of the energy sector of the S&P 500, up 68%.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA