Using your investment dollars to combat climate change or improve the conditions of workers not only reduces your returns—it probably doesn’t help the environment or labor conditions.
Wall Street has seen a tremendous boom in ESG—environmental, social and governance—investment strategies. Earlier this month, BlackRock raised around $1.25 billion for its U.S. Carbon Transition Readiness exchange-traded fund. In the first three months of this year, exchange-traded ESG portfolios listed in the U.S. took in $14.8 billion in new money, according to ETFGI, a research firm in London, the Wall Street Journal’s Jason Zweig reported last week. More than half their total assets of $86.2 billion have been garnered since the start of last year, Zweig reported.
Investors may be making a major blunder by directing so much money into the ESG trend. A new study has found that ESG funds appear to underperform financially relative to other funds managed by the same asset managers while also charging higher fees.
Perhaps even worse: self-styled ESG mutual funds tend to invest in firms with worse track records for compliance with labor and environmental laws.
The study published Monday by Aneesh Raghunandan of the London School of Economics and Shivaram Rajgopal of Columbia Business School found that the companies that ESG funds invested in, on average, exhibit worse performance with respect to carbon emissions, in terms of both raw emissions output and emissions intensity (a measure of how much emissions are required to produced a unit of revenue).
The authors do find that the ESG funds do tend to invest in companies that voluntarily disclosure more to shareholders about their emissions. But this doesn’t seem to have any effect on actual emissions.
“We find no evidence that these funds are buying firms based on expectations of future improvement and that increased monitoring by ESG funds does not correlate with any improvement in portfolio firms’ future compliance with stakeholder-centric regulations,” Raghuanuandan and Rajgopal write.
The companies invested in by ESG funds do, however, seem to be more politically connected. The study found that they spend more money on lobbying politicians and obtain more frequent and higher-value government subsidies.
It’s easy to see what’s in it for fund managers such as BlackRock. Investors are willing to pay higher fees for lower returns when funds are labeled ESG—even though the funds may be ineffective.
“Our results raise questions about what exactly the purchasers of shares in self-labeled ESG or ‘socially responsible’ mutual funds are getting in exchange for this higher management fee,” the authors write.
The results call to mind the WSJ’s Jason Zweig’s sage advice.
“Individual investors should remember that annual expenses on sustainable ETFs charge an average 0.34 percent to invest in U.S. stocks, according to Morningstar—more than 10 times the cheapest index funds. In that sense, ESG funds are Wall Street’s latest way to take something old, call it new and jack up the price,” Zweig wrote recently.
Zweig, however, pointed out that “Greenness is in the eye of the beholder.” The study by Raghunandan and Rajgopal indicates that even what’s in the eye of the beholder may just be an illusion.