by Robert Jenkins.
Anyone following the world of mutual funds over the past few years has likely seen countless headlines about ESG funds. One of the fastest growing and most hotly debated areas of investing is the incorporation of ESG values into investment portfolios. Not only are the new fund products proliferating with numerous styles and approaches being used to incorporate an ESG agenda, but the debate around performance swings back and forth seemingly by the day. The key, of course, to attaining both an investor’s ESG values and performance goals revolves around the stocks in which these funds are actually investing. That’s what this report is seeking to examine.
For many years, ESG or socially responsible investments (SRI) – to name a couple of the common nomenclatures – have been saddled with the reputation of being investment vehicles that can potentially deliver on values but often at the expense of performance. Over the years, as ESG funds have been evolving, this had much to do with the negative approach to screening out companies and industries that many early ESG/SRI funds employed. Companies that were often excluded also tended to be in industries that had generally stable cash flows and fairly decent performing stocks, such as the stocks alcohol, tobacco, gambling and, of course, energy-related stocks. Eliminating these industries tended to reduce the diversification of funds and create more volatile performance for investors while also losing the benefit of the often strong financial performance of these companies. In short, ESG/SRI funds of old had a performance problem with the possible exception of the occasional negative sector events that provided brief benefits, such as a drop in energy prices or lawsuits against tobacco companies.
As ESG funds have matured and stock selection has become more focused on positive ESG stories over negative screening, fund performance has improved. In fact, it’s been well reported of late that ESG funds are tending to either match or even exceed the performance of non-ESG funds. So, what’s driving this trend? This study aims to provide a high-level overview of what some of the more prominent ESG funds are investing in without seeking to call out individual funds or cast singular judgments in any way on the investment selection processes employed by individual managers. The fact is, the current state of ESG disclosures and company reported data is too unstandardized and inconsistent to enable such judgments.
As a fund selector in an institutional setting, I’ve had the benefit of meeting many of the top ESG fund management firms in person and getting an in-depth look at how they approach ESG investing and analysis. While they may not always agree with how they are viewed by outside ratings agencies, I can attest that there are many players in the ESG funds space that have invested considerably in building strong and experienced teams and developing thoughtful models and analytics by which to evaluate and construct well-intentioned portfolios. This study is really designed to call out what many of these funds are actually investing in and, as will be seen, some of the larger-cap ones in particular tend to agree with each other quite a bit. The desired takeaway for investors would be to simply look under the hood at a fund’s objectives and top holdings – all usually readily available on fund firms’ websites – and make their own assessment in relation to their ESG investing goals.
For more insight, download the full report here.