Enduring a difficult year, investors are questioning strategies and holdings. Many question if the bloom is off the rose for Environmental, Social and Governance strategies. From 2016 – 2020 funds emphasizing ESG standards claimed outperformance which drew lots of attention and dollars.
Now, with the market down double-digits, ESG funds are doing even worse, testing investors resolve. This should make investors question whether they are truly committed to ESG standards, or merely chasing performance.
Additionally, no matter how solid the strategy, when it isn’t working everyone starts asking hard questions. When clients ask about this, we pose questions to help them think through key issues. This is especially important given how subjective the matter is.
Recently, I was speaking to a foundation comprised of Lutherans when an ESG question came up. Instead of answering directly, my response was, “Okay, tell me the best religion.” They immediately laughed and replied in unison, “Lutheran!” Great.
However, what if the room is full of Lutherans, Baptists, Catholics, Buddhists, Muslims, and agnostics?
Now, what is the consensus on the best religion? Or, tell me the characteristics the multi-faith group must absolutely agree upon. The answer is never clear and that is the point with ESG investing. It is a murky topic with very different meanings for all people. And despite diversity in viewpoints, none are necessarily right or wrong.
Given the difficulty of the ESG puzzle, it is worth a thoughtful conversation.
As you proceed down this path, know that a variety of financial firms will gladly sell you the ESG deal of the day. Before thinking they are motivated by altruistic things, recognize there is approximately $30 trillion chasing ESG strategies. Whenever you dangle that much money in front of Wall Street, they will devise every product imaginable to sell to an unsuspecting public.
Given this, here are questions to ask your advisor before parting with your hard-earned cash:
- How do you measure success? Simply saying, “We take the moral high ground” is unacceptable. There must be clearly understood standards that can be consistently understood and applied.
- What type of rating system do you use? Although many firms claim to have a rating system, there is no widely accepted measure of what makes a quality ESG system. How long has the system been in place? What is your baseline index for comparison purposes? While maintaining ESG standards, how have you performed?
- How will investing in this product make the world a better place? Once a company goes public, shares are bought or sold from another shareholder. None of the money goes to the company itself. As such, the underlying companies are fully distanced from your ownership, or boycott, of a given security. As such, unless you invest directly in non-publicly traded companies, your investment does not change the world.
- Why is this fund different than other offerings? As of December 2021, there were nearly 600 funds purporting ESG standards. Other than clever marketing, what differentiates one versus others?
- How do you address conflicts of interest? There are conflicts in every human interaction. Which ESG factors take priority? There are many funds giving Tesla high marks for environmental advancements to electric cars and power generation. Simultaneously, other funds rate Tesla, and its founder Elon Musk, low for governance issues. So which is it? Many ESG funds ban oil and gas companies. At the same time, oil and gas companies drive the $2 trillion Texas economy. If you decide to boycott oil and gas companies, how do you explain this to the people relying on the energy sector to put food on the table?
- What will this cost? Recent studies indicate many of the largest ESG funds closely mimic the top holdings of index funds. However, ESG funds cost three times as much. Before diving in, make sure you are not just buying an overpriced index fund with a pretty wrapper.
Lastly, investors must recognize you cannot delegate ethics or automate an investment search for moral correctness. Your morals, beliefs and conscience will be different than your neighbor and you are the only one who can make these decisions.
Dave Sather is a Certified Financial Planner and CEO of the Sather Financial Group a fee-only investment management and strategic planning firm.