An Inconvenient Truth About ESG Investing

About ESG Investing

To begin with, ESG funds surely perform badly in financial terms. In the latest Journal of Finance paper, University of Chicago researchers analyzed the Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. 

That result might be expected, and it is possible that investors would be happy to sacrifice financial returns in exchange for well ESG performance. Sadly ESG funds don’t seem to deliver better ESG performance either. Researchers at Columbia University and the London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had poor compliance records for both labor and environmental rules. They also found that companies added to ESG portfolios did not eventually improve compliance with labor or environmental regulations.

This is not an isolated detection. The latest European Corporate Governance Institute paper compared the ESG scores of companies invested in by 684 U.S. institutional investors that signed the United Nations Principles of cause Investment (PRI) and 6,481 institutional investors that did not sign the PRI during 2013–2017. They did not find out any improvement in the ESG scores of companies held by PRI signatory funds subsequent to their signing. Moreover, the financial returns were lower and the risk higher for the PRI signatories.

There’s also some proof that companies publicly grab ESG as a cover for worst business performance. A recent paper by Ryan Flugum of the University of Northern Iowa and Matthew Souther of the University of South Carolina published that when managers underperformed the income expectations (set by analysts following their company), they often publicly talked about their focus on ESG. But when they overpassed earnings expectations, they made few, if any, public statements related to ESG. Hence, sustainable fund managers who direct their investments to companies publicly embracing ESG fundamentals may be over-investing in financially underperforming companies. The conclusion to be drawn from this evidence looks very clear: funds investing in companies that publicly embrace ESG sacrifice financial backs without profiting much, if anything, in terms of actually furthering ESG interests.