As environmental, social and governance investing continues to grow in popularity, investors need to carefully evaluate how their holdings will be viewed by the public. Asset managers must balance their desire to promote ESG consciousness with their fiduciary duty to drive financial returns.
ESG funds under management increased to $60 billion through June 2019, a 38% increase in the past six months, according to Bloomberg. But the overabundance of sensitive political and social issues—such as the use of tobacco and firearms; universal health care, climate change, product safety, and diversity and inclusion—shows that investors have to be more cautious than ever where and why they put their money.
Institutional investors ascribing to ESG objectives must carefully evaluate their fund holdings to ensure that all positions held align to the missions and values of the broader investment thesis. Recent headlines like the mass shootings in El Paso, Texas and Dayton, Ohio, for example, have brought reexamination of fund allocations to firearms companies. The U.S. women’s national soccer team brought mainstream attention to companies with gender pay disparity. Emerging social issues will continue to push the envelope for investors regarding what is ethically acceptable, and must be balanced with what drives earnings. A profitable investment that satisfies its fiduciary duty does not always equate to a socially responsible investment.
Aligning returns and belief
From 2005 to 2018, the number of active ESG exchange-traded fund launches grew to 52 from two, according to RSM and Bloomberg, and early data shows that 2019 will likely surpass 2018 results. Some argue that ESG has the bones to outperform other benchmarks but, in our opinion, there is not yet enough quantitatively relevant data to support this theory.
ESG investors fall in one of two camps: They expect their ESG investment to drive superior returns or they are willing forfeit yield because they believe it is the right thing to do. Some ESG investors, however, may not even know that they hold a taboo investment, leaving themselves open to the risk of a significant downside if an investment falls out of grace with the consensus, possibly due to public scrutiny of a holding in their fund.
One possible solution for investors is to have universal reporting. Corporate reporting of public companies, like the investment markets it supports, continues to evolve. Auditors and other advisors have played an important role in protecting the interests of public company stakeholders, and are beginning to play a vital role in ensuring that ESG investors have proper alignment with their investments. Industry associations will have to show why companies present sustainability and ESG reporting and display that nonfinancial disclosures do, in fact, matter to investors.