ESG Funds

Q: Are ESG [environmental, social, and corporate governance] funds a good way to invest in companies?

There’s no doubt that ESG funds have grown in popularity in recent years. Investment in (theoretically) socially and environmentally conscious businesses has nearly tripled just from 2019 ($1 trillion invested) through the end of 2021 ($2.7 trillion invested). However, I tend to be skeptical of these investment vehicles.

First, it’s worth noting that I’m not a fan of index funds in general.

Indexes in general tend to suffer from issues like overconcentration. They can be okay in modest amounts, but in general, there are better ways to use your money.

Then, we must understand that these funds are products packaged by Wall Street.

Wall Street will sell whatever it can, and the reality is that this is one more financial product that a particular brand of investor will buy. I agree with the principle of favoring companies that do good in the world, but the reality is that these funds don’t necessarily do a good job of determining which companies those are.

Their criteria tend to be overly simplistic, and what major company in the world is a saint? Big companies almost universally occupy morally gray spaces. Name a company, and I can give you 10 reasons why they should and 10 reasons why they shouldn’t be on an ESG list. I’d also argue that the better companies from an ESG standpoint usually do their “good” without any outward indicator that an ESG fund would pick up on.

So, we end up with a financial product that is highly subjective, created more with an eye on marketing than actual evidence of social, environmental, or governmental merit.

Finally, I question whether ESG funds accomplish what they are claiming.

ESG folks can take a very black and white view of what “good” should and shouldn't look like, when these questions are usually nuanced. For example, with the governance aspect, these funds are trying to identify companies that run themselves in an ethical manner. To that end, they might look at whether the CEO is also the chairman of the board (a common situation). Is that okay? Many ESG funds will say it’s automatically ethically and/or operationally questionable. In fact, there’s no one-size-fits-all answer to questions like that.

To be clear, I agree with the idea of ESG funds, just not the execution.

I will note there’s been some backlash against the concept of ESG, with some investors and politicians describing it as a “woke” approach to investing. The backlash is bad enough that sixteen states have seen anti-ESG legislation proposed that would do things like require state entities to divest from, or prohibit contracting with, companies that engage in ESG investing. My own skepticism of ESG funds has nothing to do with any of that, which is based in political or social ideology rather than sound financial decision-making.

I would simply advise investors to stay away from companies or sectors that fall afoul of your ideals – e.g., if you are concerned about the environment, steer clear of oil companies.

Then, make sure you understand how a company ticks. What is their mission, what kind of people do they hire, how loved is the company from both a customer and employee standpoint? Those kinds of questions can give you a better indication of how a company operates than an overly reductive ESG score and lead you to better investments to boot.