Putting a question mark on ESG fund performance

A study challenges the assumptions of long-term outperformance from ESG investments

Putting a question mark on ESG fund performance

An increasing number of stakeholders are buying into sustainable investments, figuratively and literally. Aside from fund providers’ growing willingness to offer values-based investment products, there’s a rising clamour from investors who want their money placed in companies with strong ESG profiles.

Another factor behind the trend is the idea that, over the long term, companies that do good also do well. That has allayed the fears of those who believe that there’s a financial trade-off to investing based on convictions. But a new study suggests that the trade-off is no myth, and must be taken seriously.

“In recent years, ESG funds have been presented to investors as socially responsible as well as likely to outperform broader based funds,” said Dr. Wayne Winegarden, PRI Senior Fellow in Business and Economics, who authored the study. “But the long-term record of ESG funds when compared to an S&P Index fund show that that's not necessarily the case.”

Winegarden arrived at his conclusions after an analysis of 30 ESG funds that have either existed for over 10 years or outperformed the S&P 500 over a short-term period. Analysing the 18 funds that have reached the 10-year threshold, the study found that a US$10,000 ESG portfolio would be 43.9% smaller than a broader fund based on the S&P 500 index. Only one of the funds would beat an S&P 500 investment over 5 years, and just two would beat it over a 10-year timeframe.

“In fact, while some funds have outperformed a passive S&P 500 index fund over select short-term periods, ESG funds rarely do so over the long-term,” he wrote.

Another risk to ESG funds, Winegarden noted, comes from their lack of diversification. He found that ESG funds put 37% of their assets on average in the top 10 holdings, while broader S&P 500 index funds which average 21% investment in their top 10 holdings.

He also tagged the problem of higher expense among ESG funds: the average expense ratio of the ESG funds he examined was 0.69%, while expense ratios for S&P 500 index funds averaged 0.09%.

All these drawbacks point to one potential negative outcome: lower returns for ESG investors over the long term. This is particularly important to institutions like public pension funds, Winegarden noted, which might get squeezed between a political push against unethical companies and the need to maximize fund growth for the sake of current and future retirees.

However, there have been studies to suggest that some individual ESG investors are prepared to give up potential return to invest in companies whose values align with theirs. And while costs of ESG funds may be high now, the rise of ESG ETFs may provide the necessary force to bring down that hurdle to ESG investment performance.


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