The “center” continues to be a lonely place in American culture, with polarization across a broad spectrum of topics. It’s now sustainable investing’s turn under the microscope, as detractors are becoming louder and more aggressive, culminating in the launch of anti-ESG funds.
I’m going to offer a controversial opinion: I posit the launch of these funds is beneficial for believers in sustainable investing.
First, differing investment objectives and views contribute to healthy and efficient markets. Second, sustainable investors argue that ESG risk and preferences lead to better risk-adjusted returns. These competing funds allow for the community to back up their claims and make a stronger case for their value proposition. Last, a free market—where investors have the choice to invest in any number of values-based funds—undercuts the main argument about investment companies imposing their will on market participants.
Robust markets are more efficient
As a portfolio manager, one of my biggest concerns is concentration in a specific factor, style or company. This is doubly true with intentional ESG portfolios, where just a handful of ESG ratings providers leads to the potential for a bunch of capital flowing toward higher-scoring ESG companies.
For ESG investors, there is a real risk of inflated valuations and reduced diversification. While clients tend to have a values-based preference, returns and financial goals matter. In this vein, having folks who are willing to invest in companies that don’t necessarily screen well on standard ESG metrics is important to prevent an overwhelming amount of capital chasing a smaller subset of the broader market.
More efficient markets and more reasonably priced ESG companies have the potential to help maximize future returns for ESG investors. Folks investing in energy companies or lower-scoring ESG sectors provide a valuable service to those who are constrained by their values—even if it seems counterintuitive or unsavory.
Proof of concept
One of the core tenets of ESG investing is that the reduction of ESG risk will lead to better risk-adjusted returns over the long term. While this has been true in the near term (many firms point to short-term results due to a lack of a long-term track record), the lack of statistical significance in the data has left the door open for debate.
Having more direct foils in terms of anti-ESG funds that have poor ESG characteristics will lead to a live track record for the sake of comparison. As live track records continue to grow for ESG funds, we should be able to highlight the claims about reduced ESG risk leading to better portfolio risk metrics relative to folks who take the opposing view. Competing views offer opportunities to further prove why ESG investors believe they have a compelling case for incorporating ESG into an investment strategy.
Free markets bolster the case for ESG
Broadly speaking, one of the main criticisms from politicians against ESG investing is that they don’t want companies forcing their beliefs on people. Whether that means a company acting in line with its social values or an investment management firm integrating a values-based approach—the overarching theme is that investors have lost the ability to control how their money is invested.
The good news about the recent spate of anti-ESG fund launches is that it undercuts these arguments at their core. Companies tend to make decisions in the best interests of their shareholders, but if investors disagree, there are no laws forcing them to remain invested in a specific security or fund. If you don’t like BlackRock’s approach to incorporating ESG risk into their investment methodology, you’re free to purchase a fund from Strive Asset Management and visa-versa.
There is no monopoly on values-based investing or companies choosing to operate in a fashion that they believe maximizes long-term shareholder capital. A compelling company or fund that attracts capital in free markets—even as they make decisions that integrate ESG—is the best vaccine for critics.
Will ESG funds continue to attract flows?
Certainly, readers of this article aren’t likely the target market of these ESG antagonist firms. Personally, I have doubts about their viability, market base and longevity.
But, if supporters of ESG and sustainably focused investing cannot outcompete these products by telling a better story, highlighting the value proposition more clearly, and attracting individuals who see investing as both a tool for generating returns and making a societal impact, then the flows will dry up and naysayers will win.
Having the opportunity to prove them wrong by outcompeting products that espouse an opposite world view should energize and excite ESG believers to prove that the continued asset growth in sustainably focused products is not a passing fad, but a robust and persistent market trend.