Imagine going to the grocery store to shop for one person with food allergies, another person on a low-sodium diet, and someone who is pre-diabetic and has to stay away from added sugars. You would rely on the nutrition labels and lists of ingredients on the packaging to know what to buy. Now imagine that food companies are not required to provide that information. That could result in a number of bad or even dangerous decisions.
Why are we talking about food ingredients and labels? It’s a metaphor for the problems created by, and the uninformed choices investors are often forced to make, due to the lack of information about what investment funds mean by “focuses on ESG” or “integrates sustainability.” It makes us think that mutual funds and ETFs need an “ESG ingredients” label.
How not to implement an anti-ESG policy
According to a recent Bloomberg article, a Texas statute that bans asset managers and banks that “do ESG” and therefore boycott oil and gas companies from doing business with the state has snared a large number of investment funds that do not focus on ESG and do not shun the oil and gas industry. That’s worth examining, regardless of your politics.
Data compiled by Bloomberg shows that almost 40 percent of the 348 funds put on the “no fly” list by the Texas Comptroller actually invest in the oil and gas industry, which Texas claims they are boycotting. Furthermore, 14 percent do not qualify as “ESG funds,” according to Morningstar, Inc. While we think that Texas’ action is driven by a reasonable desire to protect an industry that is so important to the state’s economy, it is ultimately misguided due to faulty information. But this goes far beyond Texas and its faulty list—it illustrates how ESG investing is frequently misunderstood and misrepresented, to everyone’s detriment.
According to the Bloomberg article, the Texas Comptroller “denounced Wall Street and ‘environmental crusaders’” for claiming that the U.S. can completely transition away from fossil fuels. That shows a lack of awareness of what the ESG industry calls a “just transition” toward a clean energy future. A just transition recognizes that we will still need fossil fuels as we work to reduce our dependence on greenhouse gas-emitting energy sources, and that while we move away from coal, oil and gas, we need to train workers in those sectors for clean energy jobs.
On the flipside, BlackRock, which is defending itself against Texas’s unmerited accusations (it holds more than $100 billion in Texas energy companies across its various funds), has been heavily criticized for seeming to back away from its pledge to cut CO2 emissions. Activists often criticize ESG funds for being too focused on financial performance, even though the vast majority of investors consistently say they want fund managers to prioritize returns while incorporating ESG scores or analyses into the investment process.
Is this an ESG fund? Not an easy question.
How can an investor determine whether or not a fund is “doing ESG”? Consider the following:
- Many funds with the term “Sustainable,” “ESG,” “green,” or something similar in their names do not necessarily boycott any particular industry, oil and gas or otherwise. They might, but you can’t tell from the name—you need to do some research. This is just as important for investors who do want to avoid certain industries as it is to those who prefer funds that focuses on ESG but do not screen out entire groups of companies.
- Some funds with one or more of those terms in their names have sector exposures that are quite similar to the exposures in the S&P 500 (or other relevant market index). That might mean a fund is “greenwashing”— in other words, knowingly not living up to its name—but not necessarily. Again, investors have to do research to find out what’s going on. A fund could intentionally maintain those sector exposures for diversification while over- and under-weighting specific names within each sector, based on companies’ ESG profiles.
- Then again, maybe not. According to Reuters, about 14 percent of funds labeled “sustainable” have a carbon emissions intensity higher than the average across all funds. This is just one example of why we are generally in favor of the overall goal (although perhaps not some of the details) of the Securities and Exchange Commission’s proposed disclosure requirements for ESG funds. According to the SEC, their goal is to ensure that a fund’s prospectus, annual report, and adviser brochures provide information on the ESG strategies they pursue. That could help reduce some of the ambiguity about what a sustainability or ESG-focused fund is actually doing.
- Many actively managed funds that do not have “Sustainable,” “ESG,” or “green” in their names integrate ESG analyses into their investment processes because asset managers believe it helps them to assess risks and uncover opportunities for superior returns. They are “doing ESG” but you can’t tell from the name of the fund.
- ESG is not just about “E” (environmental issues), so using “ESG” or “sustainable” as the way to ban funds that exclude oil and gas companies is choosing the wrong tool for the job. By turning public opinion in the state against ESG, Texas may find its public pension funds and other investment pools are over-exposed to companies that have poor governance, suffer high employee turnover, have labor/management problems, and so on, because the state equates “ESG” with “bad investment practices.” We also note that Morningstar estimates that over the past decade, funds pursuing ESG strategies consistently delivered returns higher than those generated by conventional (non-ESG) funds.
Keep in mind that even if a fund does not actively consider ESG at all, most companies now incorporate ESG into their business plans and strategies because they know it makes economic sense, and they know consumers care about it. According to the We Mean Business Coalition “so many companies are now setting science-based emission reduction targets,…large investors would struggle to build any kind of profitable portfolio that excludes such businesses.”
Accurate data is paramount for proper ESG assessment when making investment decisions. OWL ESG gives asset managers, investors, and advisors the unbiased data and tools they need to analyze ESG profiles and exposures in funds and portfolios. Contact us to learn more.
