A generation of investors is wedded to the promise that sustainable companies will have a long-term pay off, writes Laurie Hays.
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About the author: Laurie Hays is the founder of Laurie Hays & Associates, a communications advisory firm.
Will the first crack in environmental, social, and governance investing lead to a flood of desertions?
In May, after regulatory crackdowns and rising energy prices, the biggest class of ESG ETFs had outflows for the first time in almost six years, according to Bloomberg.
Total ESG inflows last month were barely positive, relatively speaking—about $400 million, whereas flows in 2021 averaged $11 billion and twice topped $20 billion. More importantly, equity flows were negative, with a bit more than $200 million leaving the universe of ESG ETFs. Flows into fixed-income and commodities and alternatives ETFs made up the difference.
The resulting decline in equity ETF net flows—and the plateau in cumulative flows to the asset class—means that 2022 is now running behind 2020, and investment is at less than one-third the pace of 2021, the analysis continues.
At the start of the ESG investing craze, the theory held that investors in search of companies fitting the bill would drive change and lift stock prices accordingly. Companies with high ESG scores would become more attractive as they did more to save the planet, help their employees and adhere to good governance.
Professionally managed assets with ESG mandates swelled to $46 trillion globally in 2021, representing nearly 40% of all assets under management, according to Deloitte’s Center for Financial Services. By 2024, that figure was forecast to rise to $80 trillion, or more than half of all professionally managed assets.
To be sure, one quarter does not make a trend. The momentum and marketing behind ESG aren’t likely to disappear overnight. And in many cases, social purpose is more than an investing theory; employees at many companies are putting pressure on management to adhere to the principles of ESG as well. A whole generation is wedded to the promise that sustainable companies will have a long-term pay off.
As Barron’s has reported, by eschewing traditional energy stocks and defense shares, which are having a banner year, and embracing low-carbon-footprint technology stocks, which aren’t, many ESG funds lost money in the first quarter, and underperformed their benchmarks. And in the first quarter, flows into ESG funds were holding up.
Long-term investors will be able to hold out for the inevitable switch to new energy, but as Germany fires up its coal plants to make up for the loss of Russian oil, it could be a while.
Most investors likely don’t have enough patience, and transparency into ESG practices to bet their retirement dollars on propelling the transformation of companies into sustainable businesses.
Climate is a long term, systemic risk that plays opposite to the market’s imperative to perform short term. Reform won’t produce returns fast enough to satisfy the mark. Trillions in retirement savings can’t gyrate around the price or politics of fossil fuels.
Calculating climate risk to bottom lines has proven to have too many variables to index and rank easily. The Securities and Exchange Commission is getting into the picture but so far is focused on fixing companies’ broken promises as opposed to establishing a set of standards. Sorting through the PR that hasn’t been adequately overseen on the legal side is low-hanging fruit.
PR can slip into purposeful “greenwashing,” the practice of giving investors misleading claims about products or environmental, social and governance credentials. The SEC is widely reported to be investigating Goldman Sachs’s mutual funds business in its asset-management arm, which may be in breach of ESG metrics promised in marketing materials. Goldman Sachs said in a statement it is cooperating with the SEC in the matter.
Last month the chief executive of Deutsche Bank asset-management subsidiary DWS Group stepped down a day after a raid by German authorities on its Frankfurt offices on allegations of greenwashing. DWS has repeatedly denied misleading investors, according to Reuters.
Societal matters may be too controversial for institutional investors to wade into. It’s hard to get everyone on board on abortion, gay rights and gun control. The most successful governance campaigns have focused on CEO pay.
Where will institutional investors switching out of ESG funds go? The S&P Oil & Gas Exploration & Production ETF was up 68% year to date through June 7, with a significant portion of that run-up happening in May, according to Bloomberg.
Meanwhile, as the global economy churns and fossil fuel use continues to soar, the news on the climate front gets grimmer by the month. Scientists reported last month that atmospheric concentration of heat-trapping CO2 reached its highest level in four million years, hitting 421 parts per million.
As energy expert Vaclav Smil notes in his new book, How the World Really Works, from 1989 to 2019, anthropogenic greenhouse gas emissions increased by 67%. And, despite all the happy talk of slowing climate change, developed countries only reduced their greenhouse gas emissions by 4%.
As Smil argues in an essay in Yale Environment 360, it’s time to move beyond “magical thinking”—and PR hype—and focus on the hard work of remaking our energy system.
Corrections & Amplifications: Goldman Sachs has said it is cooperating with the Securities and Exchange Commission on an investigation involving ESG metrics. An earlier version of this commentary said incorrectly that Goldman had declined to comment.
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