Amid a variety of global events, 2022 has been a challenging year for many ESG investment strategies. Energy companies, most often associated with encouraging fossil fuel dependency, have performed well given the spike in energy prices driven by supply chain issues and the war in Ukraine. However, many ESG strategies screen out energy companies over concerns about their impact on climate change. At the same time, many ESG-related investment strategies have been overweighting allocations to technology stocks, which have performed relatively poorly for most of the year.
Morningstar[i] reports that about two-thirds of U.S. equity funds with an ESG component have underperformed their benchmark year-to-date in 2022. Of course, any investment strategy will over- or underperform over shorter periods. Morningstar and other investment performance data providers have reported that ESG funds have generally performed at least as well if not better than more traditional strategies over longer time periods.
Amid growing industry pressure to comply, some states are also pushing back by discouraging ESG fund investing over a concern that financial performance is being subordinated to politics. The Texas state comptroller placed BlackRock, UBS, and eight other firms on a list of financial institutions that spurn energy companies—a decision that may affect whether these firms can manage money for the state’s pensions. The state treasurer of West Virginia announced a similar policy for five firms[ii] he believes are “working against West Virginia’s critical industries to profit off the very funds their policies attempt to diminish.” Most recently, the governor of Florida implemented a resolution eliminating ESG considerations from pension investments.[iii]
However, for the most part, this newer type of investing has been widely accepted. Certainly, there are options for portfolio managers or even individual investors who would like to be sure their money is supporting companies that share their views. Vanguard[iv] actively promotes ESG funds on its website as “a great way to complement your portfolio with funds that reflect your values.” Fidelity[v] offers a multitude of information for anyone wishing to “align your investment objectives with long-term trends considered important to the overall sustainability of a business, such as sound business practices and governance.”
Not all funds are on board. Notably, Strive Asset Management was founded by investors, including Peter Thiel and Bill Ackman, who are very vocal about their distaste for ESG investing. The firm’s first foray into anti-ESG investing was through its flagship ETF US Energy (NYSEARCA: DRLL) which has exceeded $238 million in assets under management and over $320 million in traded volume in its first two full weeks of launch.
But not all anti-ESG funds have been successful. The B.A.D. ETF (BAD) was launched in late 2021 with a focus on the types of companies that are often screened out of ESG-aligned investment strategies (B.A.D. stands for betting, alcohol, and drugs). However, the fund has only been able to attract about $7.8 million in assets and has lost 16% this year, worse than the 13% decline by the S&P 500 Index over the same period.
Key Concerns in ESG Investing
There is still work to do here. Investors and issuers have both been very vocal in recent years about the need for broader and deeper disclosures around the socially responsible and environmentally sustainable impacts of the companies or initiatives that are being funded by the capital markets. Organizations such as the Sustainable Accounting Standards Board (SASB) and the Carbon Disclosure Project (CDP) have created popular frameworks enabling issuers to disclose ESG factors in more transparent and standardized formats. While there seems to be an alphabet soup of acronyms in this landscape, the recent consolidation of SASB and the International Integrated Reporting Council (IIRC) into the Value Reporting Foundation (VRF) suggests that there are market pressures encouraging the development of a single disclosure standard that all issuers can adopt.
Future SEC Guidance a Solution?
The SEC recently released two proposed rulemakings designed to provide clarity around ESG disclosure standards for the industry. The Enhancement and Standardization of Climate-Related Disclosures for Investors proposal specifies standardized climate factors that registered issuers will need to provide to investors. The Enhanced Disclosures by Certain Investment Advisers and Investment Companies about ESG Investment Practices proposal would require enhanced disclosures for fund managers that incorporate ESG into their investment strategies. While it is likely that these proposals will undergo substantial revisions before they are adopted, they would go a long way towards satisfying the demand for additional transparency regarding ESG factors from issuers, investors and other capital markets participants. This could pave the way for greater understanding and adoption across the board while easing concerns about ESG investing.
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