ESG investing (and extra characters)

Investment Analysis Clubs Macro Economic Trends and Risks
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" In a recent Journal of Finance paper, University of Chicago researchers analyzed the Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. Although the highest rated funds in terms of sustainability certainly attracted more capital than the lowest rated funds, none of the high sustainability funds outperformed any of the lowest rated funds…

"Unfortunately ESG funds don’t seem to deliver better ESG performance either…

“Researchers at Columbia University and London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance record for both labor and environmental rules. They also found that companies added to ESG portfolios did not subsequently improve compliance with labor or environmental regulations.”

DB2

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investing is about making money, not about saving the planet.

Want to save the planet? Ban investing!

But before you do, is that the planet you want to live on?

The Captain

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It is not that simple. Non ESG company operations have liabilities that are not compensated yet. There is much more of a clean up that will need to be funded among the non ESG companies. The affects of negative externalities can bite you.

There are also future returns ESGs that might surprise widely to the upside. If the US begins to lead in exporting ESG capacities to the emerging economies, then ESG can become a cash cow while crowding out polluting competitors.

It is a matter of deciding economically in time if you are in the right place or sectors.

We have an older population here that just wants their dart to hit XOM on the newspaper ticker symbols.

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TL;DR - ESG mutual fund managers are basically taking advantage of their investors without actually delivering on ESG goals.

Reading the full article, it sounds like the problem is not ESG investing. It is the mutual fund managers selecting companies to purchase based on what they say about ESG rather than taking the time to look at what they actually do.

For example:

Researchers at Columbia University and London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance record for both labor and environmental rules.

However, the article also dabbled in a bit of ivory tower thinking.

in competitive labor markets and product markets, corporate managers trying to maximize long-term shareholder value should of their own accord pay attention to employee, customer, community, and environmental interests. On this basis, setting ESG targets may actually distort decision making.

While the theory says that company management should seek to maximize long-term shareholder value, in practice such management is rare. There are an awful lot of companies managed by people looking to maximize their short-term personal finances rather than that of shareholders. Such problems are one of the biggest issues in corporate governance today - how to align top management incentives with those of shareholders and investors.

It would appear that top management of mutual funds is not immune from this corporate governance problem.

–Peter

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Yes, greenwashing is a problem, and ESG ratings can be difficult to use. But there are plenty of choices today, and expense ratio and performance looks acceptable for the largest funds. The “compliance record for both labor and environmental rules” varies greatly by industry, and so is a poor ESG measure. DSI and SUSA have been around over 15 years, what have they done that is inconsistent with their prospectus?

The largest ESG US equity ETFs (I use BIAWX and PRILX):

ESGU avoids: controversial weapons, oil sands extraction, small arms, thermal coal and tobacco.

ESGV avoids: adult entertainment, alcohol, tobacco, cannabis, gambling, chemical and biological weapons, cluster munitions, anti-personnel landmines, nuclear weapons, conventional military weapons, civilian firearms, nuclear power, and coal, oil, or gas.

DSI avoids: adult entertainment, alcohol, civilian firearms, controversial weapons, conventional weapons, fossil fuel extraction, fossil fuel reserves ownership, gambling, genetically modified organisms, nuclear power, nuclear weapons, thermal coal power and tobacco.

SUSA avoids: alcohol, civilian firearms, controversial weapons, conventional weapons, fossil fuel extraction, gambling, nuclear power, nuclear weapons, thermal coal power and tobacco.

Symbol Assets[$M] ER 3yTR 5yTR 10yTR 15yTR Name
PRILX 25,160 0.61 11 12 13 11 Parnassus Core Equity
ESGU 20,569 0.15 10 11 - - iShares ESG Aware MSCI USA ETF
ESGV 5,856 0.09 9 - - - Vanguard ESG U.S. Stock ETF
BIAWX 5,850 0.78 10 13 15 Brown Advisory Sustainable Growth
DSI 3,730 0.25 10 11 13 9 iShares MSCI KLD 400 Social ETF
SUSA 3,409 0.25 11 11 13 9 iShares MSCI USA ESG Select ETF
USSG 3,073 0.10 10 - - - Xtrackers MSCI USA ESG Leaders Equity ETF
SUSL 2,979 0.10 10 - - - iShares ESG MSCI USA Leaders ETF
NULV 1,624 0.25 6 8 - - Nuveen ESG Large-Cap Value ETF
LCTU 1,447 0.14 - - - - BlackRock U.S. Carbon Transition ETF
CRBN 863 0.20 6 6 - - iShares MSCI ACWI Low Carbon Target ETF
NULG 848 0.25 12 14 - - Nuveen ESG Large-Cap Growth ETF
PABU 763 0.10 - - - - iShares Paris-Aligned Climate MSCI USA ETF
SNPE 730 0.10 12 - - - Xtrackers S&P 500 ESG ETF
KRMA 664 0.43 9 11 - - Global X Conscious Companies ETF
EFIV 645 0.10 - - - - SPDR® S&P 500® ESG ETF
USXF 632 0.10 - - - - iShares® ESG Advanced MSCI USA ETF
SHE 214 0.20 4 6 - - SSGA Gender Diversity ETF SPDR
average 4,392 0.23 9 10 14 10 average
VFINX 274,460 0.14 10 11 13 9 Vanguard 500 Index

links:
(Top ESG Rating Providers, June 2021)[The Top ESG Rating Providers And How To Use Them] : “ESG ratings can vary depending on the provider due to the different methodologies, metrics, data and weightings they use. Most investors find this confusing and difficult to compare… The biggest ESG rating providers are considered to be MSCI and Sustainalytics, mainly due to their wide coverage. Bloomberg, and Refinitiv (formerly Thomson Reuters) as well as credit ratings agencies like Moody’s, S&P and Fitch also provide ESG ratings.”

(Refinitiv ESG company scores)[ESG Scores | Refinitiv]
Search funds | Fossil Free Funds
MSCI ESG Indexes - MSCI

Guide To Socially Responsible ETFs, 2016 : “Below we highlight a few popular socially responsible ETFs that could be on investors’ wish list… DSI… iShares MSCI USA ESG Select ETF… CRBN… SHE”

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The OP articles reference Morningstar Sustainability ratings. These don’t seem to vary much, and so I don’t find them of much use. (On a 50 point scale, 18.6 score gets a 5 rating, and 21.6 score gets a 3 rating.)

Corporate ESG Pillars (lower scores = lower risk) (Corporate Sustainability Score 0 is Low Risk, 50 is Severe Risk) from Morningstar:

Carbon Corporate Morningstar
Risk Sustainability Sustainability Sustainable
Ticker Score Score Enviromental Social Governance Rating Investment
PRILX 4.6 18.6 3.3 8.6 6.7 5 Yes
ESGU 6.8 20.8 4.0 9.4 7.3 4 Yes
ESGV 5.1 20.5 3.0 9.3 7.1 4 Yes
BIAWX 2.4 18.4 2.8 8.9 6.7 5 Yes
DSI 5.0 19.3 3.4 8.9 6.8 5 Yes
SUSA 5.2 18.7 3.5 8.3 6.7 5 Yes
USSG 4.9 19.5 3.1 9.2 7.0 5 Yes
SUSL 4.9 19.5 3.2 9.2 7.0 5 Yes
NULV 7.1 21.2 4.4 9.0 6.8 5 Yes
LCTU 6.4 20.8 3.7 9.6 7.4 4 No
CRBN 7.3 21.5 3.9 9.6 7.6 3 No
NULG 3.7 17.9 2.7 8.9 6.5 5 Yes
PABU 4.8 20.2 3.1 9.4 7.5 4 No
SNPE 6.2 20.8 3.9 9.5 7.4 4 Yes
KRMA 5.8 19.9 3.8 9.3 6.9 4 Yes
EFIV 6.2 20.8 3.8 9.4 7.4 4 Yes
USXF 4.7 18.2 3.2 8.3 6.4 5 Yes
SHE 6.2 20.5 3.8 9.4 6.5 4 No
VFINX 7.34 21.6 4.2 9.8 7.5 3 No
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Something I don’t understand. If students at XYZ college protest the college endowment’s holding of 1,000 shares of, say, MO, and as a result the endowment sells it’s 1,000 shares of MO, how will this affect the profitability of MO? Does MO know this happened? Does MO management care?

The principles of ESG sounds good to the extent it helps investors understand managements intent. It also has the ring of Bernie Madoff style deception.

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Look to South African apartheid.

A corporation lives in its financial and business environment. The deterioration of that environment for the corporation makes capital relatively more expensive. Some of the offending companies will be crowded out.

I am not asking anyone to like that or dislike that. Liking/disliking it is irrelevant.

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So for the cost of capital to increase due to select group opinion (I guess), there would have to be fewer individuals/institutions willing to buy issued stock and somehow increase the company’s risk profile to reduce the credit rating and thus increase the cost of debt?? I’ve always thought that a company’s profitability going forward determined this.

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I would guess the endowment’s selling has little effect on MO. MO management might even welcome it as an opportunity to buyback stock at a lower price.

There is a feedback loop between the stock price and the company’s profitability going forward. A higher stock price gives a company options and improves employee morale. This can lead to higher profitability. Higher profitability supports a higher stock price. This feedback loop is vital for some companies (e.g. Enron) and unimportant for some (e.g. MO and other companies buying back stock).

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In theory, the answers are: it doesn’t, no, and no.

But in practice, management doesn’t stick to increasing the stock price by producing good profits. They often attempt to affect the stock price directly by participating in the stock market in some way, and by attempting to talk the price up.

So in the real world, the answers to your questions are: it doesn’t (which is the same as the theory), yes they certainly know about significant stock transactions, and yes they care an awful lot.

As to that last one, when top management is given incentives to have a higher stock price, that is exactly what they will do. And they will not limit themselves to only making the company more profitable to achieve that goal.

—Peter

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All major corporations calculate an IRR for different projects. Then they finance what makes sense up to the utility of their borrowing at market interest rates. If the company is falling out of favor it is not just their cost of borrowing, it can be their consumer base in part. As I worded it their “environment”.

The less of a useful IRR for projects the more in decline a corporation is.

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Yes, to the extent perceptions affect brand, sales can decline. I suspect this is what happened to DIS in March with the comments of Disney’s president of general entertainment division. But I don’t see the connection of ESG scores, stock ownership and revenues. Short term stock price movements will happen, but ultimately its earnings projections, meeting those projections and potential future events that can affect earnings that have a material effect on the direction of stock price.

Just got in my e-mail basket from PlanSponsor this 11/27 WSJ Editorial on ESG ratings in ERISA plans

On Tuesday the Labor Department finalized a rule that empowers retirement plan sponsors to invest based on environmental, social and governance (ESG) factors and put your 401(k) to progressive political work.

The Labor Department casts its rule as a mere clarification of the 1974 ERISA, which requires that retirement plan sponsors act “solely in the interest” of participants and beneficiaries. A Trump Labor rule barred retirement managers from considering factors that weren’t material to financial performance and risk.

Asset managers and union pension plans claimed the Trump rule limited their discretion to consider such ESG factors as climate, workforce diversity and labor relations. The Biden DOL says it created a “chilling effect” on ESG investing. Its replacement rule gives plan sponsors nearly unlimited discretion and legal protection to invest based on these often political considerations.

A fiduciary may reasonably conclude that climate-related factors” including “government regulations and policies to mitigate climate change, can be relevant to a risk/return analysis of an investment,” the rule says. Ditto workforce diversity, inclusion and labor relations since they may affect employee hiring, retention and productivity.

The main point of the Biden rule is to give legal protection to retirement plan fiduciaries that invest based on ESG. A secondary goal is to steer more retirement savings into ESG funds that often charge higher fees by allowing retirement sponsors to offer them as default options in 401(k) plans. Workers automatically enrolled in default funds can opt out, but they usually don’t.

http://stump.marypat.org/article/1674/esg-and-erisa-pity-the-poor-tort-lawyers-their-lost-business-as-biden-gives-a-safe-harbor-for-now

And keep in mind, FTX had stellar ESG ratings right before implosion

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So are you for or against ESG investing?

Do the issues addressed matter to you? Or not?

Others prefer their money not go to gun manufacturer, big tobacco, and oil companies. That is a normal sane investing not supporting the crazy old guard. Or does not gore your ox?

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“Vanguard indicated its decision rested in a desire to maintain the freedom not to restrict its investment options.”

DB2

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Big ESG Funds Are Doing Worse Than the S&P 500

https://www.wealthmanagement.com/etfs/big-esg-funds-are-doing-worse-sp-500
The 10 largest ESG funds by assets have all posted double-digit losses, with eight of them falling even more than the S&P 500’s 14.8% decline.

DB2

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My esg fund underperformed the S&P this year because it was tech heavy. But it still beats the S&p over five years. Too lazy to look up the five year numbers for the companies cited in your article.

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And it was probably light in the oil and gas industries.

DB2

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Yep plus twenty letters.

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That can be a problem when profits are increased by ignoring a range of costs the business does not pay–i.e. costs that are socialized because they can be. Remember all the companies having to pay “after the fact” expenses to start to begin cleaning up the messes the company left to the public to pay?

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