Why ESG Investments May Not Deliver the Returns You Expect
ESG investing, which focuses on environmental, social, and governance factors, has gained significant attention from financial institutions in recent years. They have marketed these investments as the future of finance, with the promise of strong returns. However, when examining ESG investing more critically, we find that the financial outcomes may not align with these expectations.
Research into ESG investing reveals mixed results. It is crucial to understand that while ESG investments may be marketed as offering superior returns, they often don’t outperform conventional investments. The central idea behind ESG investing is to evaluate companies based on their sustainability efforts, but the question remains: does this approach actually translate into better financial performance?
Impact on Risk and Returns
Several studies have investigated the relationship between ESG practices and financial returns. For instance, a review by NYU-Rockefeller of over 1,000 papers from 2015 to 2020 found that companies focusing on ESG metrics generally showed better financial outcomes, such as improved return on equity or asset performance. However, when considering fund managers’ ability to consistently select high-performing companies based on ESG criteria, less than 35% of studies showed outperformance.
Further research by Dimensional Fund Advisors examined the emissions levels of companies in various markets and concluded that emission data did not provide meaningful additional information about a company’s future profitability. The study suggests that the environmental focus does not necessarily correlate with higher expected returns.
In Vanguard’s 15-year study of US-listed stocks, they found no significant difference in the performance of ESG-focused funds compared to the broader market. The results indicate that ESG funds do not consistently outperform or underperform the market.
The Cost of Implementation
Our research suggests that while ESG investing does not inherently lead to higher returns, the process of implementing ESG strategies may increase costs. Adding ESG considerations to a portfolio often involves additional constraints, which can reduce diversification and increase expenses. Therefore, while ESG investing may not alter the return potential of a portfolio, it is likely to reduce its overall performance due to these added costs.
The Challenges of ESG Evaluation
One of the major obstacles in ESG investing is the inconsistency in how companies are evaluated. Different ESG data providers, such as MSCI and Sustainalytics, use varied methods and weights to assess companies. For example, MSCI assigns separate scores to environmental, social, and governance factors, while Sustainalytics combines these into one overall score. These differences in methodology highlight the challenges of assessing ESG performance consistently across companies.
Conclusion: Looking Beyond Financial Returns
While ESG investing offers a way to align investments with personal values, the financial returns may not be as promising as some may hope. Therefore, it is crucial to view ESG investments not through the lens of financial profit but as a means to foster positive societal impact and corporate responsibility. For financial advisors and firms, integrating ESG investments into their offerings can demonstrate a commitment to social responsibility, even if the financial benefits are not guaranteed.
At Providend, we believe that ESG investments align with our core mission of promoting positive societal change, but we also acknowledge that they may not lead to higher returns. We encourage clients to consider the broader impact of their investments and focus on their values, rather than solely on potential profits.
