Why was 2022 the Year of Attack on ESG Investing?

2022 was a tough year for stock markets (7th worst year ever), bond markets (worst year ever), and misleading news headlines. A particular headline that has come in to focus is the attack on ESG investing. A few clients have asked us our thoughts, which we are more than happy to share.

Why is ESG investing under attack?

Why? Simply “follow the money”. The chart below from Bloomberg depicts the flow of money from traditional funds to ESG-mandated funds from 2015 to 2020 and creates a projection through 2025. The clear direction is: up. ESG investing has evolved from a small niche market to widespread adaptation. In turn, this means that traditional fund managers have less under management and thus less revenue coming in the door. One way to get their revenue back up? Spread “misleading news” about ESG investing. Our interpretation is that traditional fund managers are finally starting to feel a true threat to the future of their revenue.

What is ESG?

There has been significant confusion around “what is ESG investing?” in the past with a ramp up in 2022 primarily due to politicization of the issue.  Per the CFA Institute, “ESG stands for Environmental, Social, and Governance. Investors are increasingly applying these non-financial factors as part of their analysis process to identify material risks and growth opportunities. ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual report or in a standalone sustainability report.”

The three main ways to invest with ESG data are:

The main confusion we have seen over the years (especially from politicians in 2022), is conflating “Exclusionary investing” with “Best in Class investing”.  One of the most common exclusionary approaches is fossil fuel-free investing.  Fossil fuel-free investing generally avoids investing in companies that derive revenue from fossil fuels. Investors that take this approach (or any exclusionary approach) are willing to receive returns that are different from a traditional benchmark.  They may or may not receive a lower financial return over time to support their values and they are fine with this potential trade-off.

Example:

Company A & Company B are both in the same industry.  Company A has a better environmental score, social score, and governance score.  Company A also has a better overall ESG score than Company B.  

Which stock would you buy?

If you are a “Best in Class ESG investor”, you would overweight Company A in your portfolio.  

10 Year Total Return (as of 01/06/2023, data provided by Kwanti)

Company A  =  141.59%

Company B  =  89.93%

Company A is Chevron (CVX), and Company B is Exxon Mobil (XOM).

Did you happen to notice that both companies are in the energy sector and derive a significant portion of their revenue from fossil fuels?  We showed you this example to drive home the point that ESG data applies to every company in every industry.  The “E” helps us to see if a company is efficiently using their natural resources, the “S” helps us see if a company is efficiently using their human resources, and the “G” lets us know how the company is managing risk (or creating unnecessary risk).

Misleading news headlines and politization of ESG investing has created doubters. However, alongside Blackrock and Jim Cramer from CNBC, we believe that ESG investing should not be a political football. We are disappointed to see that it has become one. Taking ESG factors in to account helps drive better long-term risk/return characteristics in a diversified portfolio.

“Companies can be good citizens and make a profit too. They can support local communities without sacrificing their ESG objectives. And investors can get a return on their investments without destroying the planet. But it might take a kinder and gentler approach on all sides. Let’s hope for that in the new year.” Forbes