ESG Investing Will Never Recover is Possible
There was likely a time when the ESG brand was at its peak. Investment products centered around ESG issues were all the rage for three years, but a review of quarterly data by Morningstar Direct shows that the percentage of newly created funds in the US and Europe with ESG in their name has dropped from 8.3% to 3.3%.
Similarly, Google Trends shows that the number of searches for “ESG investing” has dropped back down to where it was in the middle of 2019. According to FactSet data, the number of times the term is mentioned in company analyst calls has decreased by 59% since reaching a high point in 2022.
Maybe it’s because the clean-energy equities that are most commonly linked to the ESG movement have fallen in value. Tesla, a giant in the electric vehicle industry, has seen its sales growth slow. As renewable-energy projects have been shelved, the S&P Global Clean Energy index—which includes solar-panel producer First Solar and Danish wind-turbine major Vestas—has lost 31% since the start of 2023. That is in contrast to the 27% returns seen by worldwide stock markets.
From 2019 to 2022, clean technology valuations surged in tandem with the growth of ESG investing; however, the current trend is the inverse. According to EPFR, investors have removed $2.2 billion from decarbonization funds since the beginning of the year, and the outflows are growing larger each week.
Rather than a widespread financial revolution, there’s a chance that ESG was just a passing investment trend.
The word was born out of a tense trilateral agreement. A group of investors with strong moral convictions—including pension funds, educational institutions, and religious groups—banded together to oppose companies involved in controversial political issues. This group was especially prominent in Scandinavia. On the other hand, there were organizations like the United Nations that tried to direct funds to businesses that did good for society. At long last, there were financiers hoping to cash in on the green movement.
When given the opportunity, asset managers eagerly catered to all three at once. In an era of falling fees, ESG enabled them to charge more for stock screenings that frequently result in minor adjustments to allocations, distinguish their offerings from competitors, and reinvigorate the argument for active management. According to statistics from Morningstar Direct, the average asset-weighted charge for U.S. equity funds implementing ESG techniques is 0.52%, while the overall fee is 0.33%.
However, there were many paradoxes and instances of doublespeak due to the muddled motives. Fund managers assert that ESG is a comprehensive route to safer, greater returns, which does not make sense when considering ethical goals or wagers on decarbonization.
Yes, increased corporate disclosures may bring an ESG focus into sharper focus for active managers, allowing them to better account for risks like regulatory backlash or governance blowup. A move toward mandating improved reporting and handling of sustainability consequences by businesses was passed by the European Union this month.
But it appears like they’re operating under the wrong idea that using ESG factors in their screening will improve their stock selection. Given ESG’s widespread interest, it’s implausible that investors are ignoring the dangers. Shares with high sustainability ratings run the danger of becoming too costly and leading to inferior returns, as seen in the influx of capital into Vestas, whose stock reached a price-to-earnings ratio of 534 in 2022.
Even if ethical investors are okay with this, the question of what constitutes ethics will remain unanswered. U.S. politics around electric vehicles and Bud Light beer culture battles demonstrate how readily firms can become ideological battlegrounds, which is why interest in ESG has declined there.
When dealing with these kinds of problems, ESG ratings aren’t very useful. A February research from the Leibniz Institute SAFE found that even within the specific “E,” “S” and “G” criteria, different suppliers provide very varied rankings to the identical companies. Furthermore, the majority of the overall score can be explained by environmental concerns, according to the researchers.
Here we have one another piece of evidence suggesting that the need for theme investments during the epidemic may have been the driving force behind the ESG revolution. As shown by the rapid expansion of companies like Global X, which provides more specific services like electric battery tracker funds, cloud computing, and services for aged populations, it has since discovered more reliable means of subsistence.
A Morningstar investigation from November revealed that these goods’ buyers can be fickle and move on to the next topic too fast, which isn’t always a good thing. As its constituent sections rebrand to appeal to their respective target audiences, the overly generic ESG brand may never regain its lustre. The biggest fund manager in the world, BlackRock, has already abandoned it in favor of a focus on transition themes rather than corporate ethics.
Putting money into sustainable projects is here to stay. On the other hand, no one benefits from a wide tent that accommodates too many interests.
