The Trouble with ESG Investing

Environmental, Social, and Governance (ESG) investing has become increasingly popular.  According to Morningstar, over $51 billion flowed into this investment strategy in 2020.[i]  That’s not a surprise, given the prospect of no longer having to choose between our values and making money. 

Unfortunately, while developments are promising, there’s still much work to be done to consider ESG a viable investment strategy.  In fact, ESG seems to have more gray areas than green ones, so it’s critical that you know exactly what you’re buying.

If you’re interested in ESG investing, here are some issues to consider.

1. Lack of a universal definition
   
   

There is no one definition of what exactly comprises an ESG qualified investment, so expect a lot of variation. This variation can lead to some unexpected results.

For example, you may find that some companies popular in ESG funds are forward-thinking on environmental issues but poor on LGBTQ or worker conditions. This Forbes article details several household names that, despite their “ESG” positive reputation, donated millions to anti-gay politicians.[ii]  

ESG funds are all over the map, too.  Some filter companies based on their current ESG ratings, while others get on boards of companies not currently very ESG and push for change.  ETFs can passively follow an index of ESG companies that someone else created.

As you can see, an ESG label doesn’t tell you much. 

2. Reporting standards and regulations do not yet exist

Amid all the enthusiasm, the whole ESG concept is very much still in the Wild West phase.  There are no standards in place and certainly no regulation. 

Several companies are attempting to establish themselves as ESG rating agencies.  These firms are trying to define metrics and standards, but it is still very, very early.  As an investor, you need to trust that these firms get the information they need and analyze it consistently. With no enforceable reporting requirements for ESG, there is no assurance that they are even using accurate raw data.    

3. Beware of “greenwashing” 

Some corporations have added initiatives to make them attractive to ESG investors.  For example, traditional energy companies may add green energy programs, and large food conglomerates may focus on bottled water’s “eco-friendly” containers.  A loose definition for ESG may allow managers to include tangentially related firms in an effort to boost performance, despite the objections many may have with the core business of those companies.

4. Performance

While the future might be bright for alternative energy, that doesn’t mean this is the time to buy.  Generally speaking, we typically see ESG performance lagging that of the overall market based on valuations alone.  This could get worse over time with people piling into a strategy with limited investment options. Also, many alternative energy companies are difficult to value because of a lack of earnings or because much of their revenue can come from government sources, and those amounts can vary greatly based on the party in power.

An Alternative ESG Strategy

We support the concept of ESG investing because it matches our own social desires.  However, until there are uniform qualifications for ESG companies and valuations come down, we think there are other ways to help promote change while maximizing growth potential.  Consider an option that:

• Uses a long-term investment strategy to help maximize growth potential.
• Eliminates sectors or companies you find objectionable (such as fossil fuels, guns, or tobacco).
• Then, use some of your portfolio’s growth to donate to charities that directly influence environmental, social, or corporate governance change. This could help promote change more than simply owning stock in a “feel-good” company.

All investment strategies come with pros and cons.  For those who have weighed the pros and cons of ESG investing, investing some or all of your portfolio in ESG is fine so long as the strategy doesn’t negatively impact your long-term goals.

The opinions voiced in this material are for informational purposes only and are not intended to provide specific advice to any individual.  Consult your legal, tax, and/or financial advisor to determine what is appropriate for your situation.

As a Registered Investment Advisor (RIA), Partnership Wealth Management is committed to providing our clients with financial planning and wealth management services to help them work towards their financial goals. At Partnership Wealth Management, we have a long history of working with the LGBT community. Among the many services we offer are financial planning and estate planning strategies for gay and lesbian couples. Financial planning is an important part of preparing for the future; contact us today to get started: www.partnershipwm.com.

[i] https://www.morningstar.com/articles/1019195/a-broken-record-flows-for-us-sustainable-funds-again-reach-new-heights

[ii] https://www.forbes.com/sites/dawnstaceyennis/2019/06/24/dont-let-that-rainbow-logo-fool-you-these-corporations-donated-millions-to-anti-gay-politicians/?sh=29596d2814a6