“If everything is ESG, then nothing is.” That’s the word from a recent Horizons ETFs report, which highlights why an ESG fund might not actually be as responsible as an investor might think.
The rush of institutional and mom-and-pop investors towards funds with environmental, social, and governance mandates (ESGs) has saturated the space. Demand for ESGs, especially among women and investors under 40, has given rise to a raft of ESGs that profess responsibility. Horizons says a look under the hood of some of those funds might disappoint most socially conscious investors.
Social consciousness is hard to quantify, and a number of companies can struggle to meet the ‘check-box’ standards that nascent ESG raters set. Others aim to only meet a bare minimum responsible investing standard. Horizons says this is driven more by a marketing push than a real desire to build a socially responsible fund.
The Horizons report says that plenty of ESG funds are simply a relabelling of a classic index fund. Both might carry a 5% exposure to oil and gas, for example, but that 5% is under the minimum responsible investing standard. A fund could call itself ESG but carry an asset that the socially conscious investor wants to avoid, all while charging that investor a premium for their ESG status.
Many of these funds factor wider ESG data into their selection process, without actually screening the equities they’re taking on. Horizons advocates for funds that combine negative and positive screening practices. Negative screening systematically excludes companies, industries, or sectors based on ethical considerations. Positive screening allocates capital to companies selected for their positive ESG status. Funds that apply both methods will meet almost any ethical investor’s standards.
There isn’t any uniform regulation governing ESG status, leaving it up to advisors to puzzle out what funds will meet their clients’ needs. It might seem like a lot of work, for what is widely understood to be a low-return asset class. That’s where Horizons’ says there’s hope.
At the moment, oil and gas stocks aren’t exactly a safe bet, firearm manufacturers aren’t outperforming tech or health care stocks. Investors are flocking to consumer staples, given a general unease in the market. It just so happens that some of the fundamental cores in ESG funds, are performing well. Of course, the devil’s in the details but Horizons noted their own Global Sustainability Leaders Index ETF, which returned 16.95% in 2019.
Clearer regulations will make the ESG space easier to navigate, for advisors and investors alike. But Horizons makes a case that doing a little digging might find an ESG that both meets a client’s ethical standards and produces a respectable return.