By now, anyone who even reads about investment strategies has probably heard about ESG generating value. As the equities market moves races towards this shiny new object, executives of companies held by fund and managers rush to satisfy investor strategies. Institutional Investor just published an in-depth article written by Kenneth Pucker, former COO of Timberland, exploring his view of where we stand in ESG investment and impacts, which are not equivalent.
Is there ESG Alpha?
Pucker argues that there is not really ESG alpha. Instead, the matter is more nuanced.
… even if ESG funds perform well, it is not clear if the relationship between ESG and financial returns is causative or correlative. It could be that financial returns and ESG are both a function of good management. Scientific Beta, an index provider linked to a French academic think tank, agrees. “ESG strategies perform like simple quality strategies mechanically constructed from accounting ratios,” Scientific Beta research director Felix Goltz told the Financial Times. “There is no ESG alpha.”
He also raises intra-sector coincidences that provide a potentially false view of ESG performance when looking across divergent sectors:
… sector-based exposure was one of the key drivers behind the recent short-term outperformance of many ESG funds relative to their non-ESG counterparts, as tech stocks rallied in 2020 while energy stocks declined,” MSCI noted.
Finally, Pucker bares his cynicism with this statement:
ESG may or may not be a source of outsize returns for investors, but asset managers are winning by managing these funds. According to data from FactSet, the fees for ETFs defined as socially responsible investments are 43 percent higher than the fees for standard ETFs. The Wall Street Journal wrote that this may be one reason “asset managers are among the biggest cheerleaders for sustainable investing.”
ESG Investment is Not Impact
The author also cautions that successful investment strategies are not the same as ESG impact:
ESG funds are measured against benchmarks for financial returns; they are not measured on the impact they deliver… The increased investor preference for ESG assets and the long-past-due work to standardize sustainability reporting and regulate ESG investing. That said, do not expect these shifts to adequately address social and environmental problems.
What This Means for Companies
There is a yin-yang between investor actions/preferences and actions taken by the companies in which they invest. In many ways, companies must be responsive to investor/fund manager actions and demands regardless of whether those strategies are actually successful for the investor/manager. Investor focus on ESG – for whatever reason – means investee companies have to make decisions about how to address ESG for themselves.
Each company must make their own assessments and decisions on ESG implementation, considering investor demands and goals, as well as their own operating environment. Investor pressure alone may not justify ESG actions, initiatives or expenditures. Easily quantifiable internal business cases may exist in terms of operational cost savings, supply chain rationalization, or new product/market development that support themselves regardless of the ESG tag. Other ESG initiatives have softer benefits; those are ones where investor pressure (or lack thereof) can tip the scale.