Doubts about ESG funds aren’t slowing their spread
Money managers are tilting toward ESG, whether they want to or not
IF YOU buy a fund with sustainable, ethical or green in its name, are you really getting something different from everyone else? Or are you all too often getting much the same thing, just with a more compelling name? Is there an epidemic of greenwashing? The UK’s Financial Conduct Authority (FCA) has long suspected the latter – hence the introduction of new regulations that will come into force early next year around the labelling of funds.
The FCA was, as it turns out, quite right to be suspicious. A new paper from London Business School professor of finance Alex Edmans and executive fellow of finance Tom Gosling, Sustainable Investing: Evidence from the Field, delivers the evidence. Edmans and Gosling surveyed more than 500 equity portfolio managers running funds both focused on environmental, social and governance (ESG) factors and traditional ones in the US, UK and European Union; they questioned the extent to which the managers differ when it comes to incorporating environmental and social metrics into their investment decisions. The (fairly surprising) first part of the answer is that mostly they don’t differ much. The second part is that the FCA might actually be worrying about the wrong thing.
Given a list of factors (including strategy and competitive position, operational performance, governance, corporate culture and capital structure) that they felt might affect the performance of a firm, both sustainable and traditional managers put E (environmental) and S (social factors) last (by quite a long way).
This isn’t to say they see a focus on E or S as not providing alpha. But they view either more as a function of success elsewhere (good management, for example) rather than a performance enhancer in their own right. They also seemed to see little need for E and S improvement at all. Asked if companies are over or underinvesting in E and S metrics, the average view was that things are in much the right sort of place – in fact, 44 per cent suggested there is some overinvestment in greenhouse-gas-emission reduction. But the overall view is that the industry considers the corporate world to be not far off being E-S optimised already.
Even if managers of either type of fund did feel improvement was needed, there is little evidence they fancied being the ones to push for it. A mere 2 per cent of traditional fund managers and 5 per cent of sustainable managers would tolerate even 0.5 per cent of return being sacrificed by a company in a bid to improve E and S performance. Overall, only 27 per cent (24 per cent traditional, 30 per cent sustainable) “would tolerate companies sacrificing even one basis point of annual return for ES performance”. Left to their own devices, there is clearly no way that the fund managers of the West, sustainable or traditional, are keen to invest with a view to saving the world. They aren’t convinced there is much to fix – and if there is, they aren’t (quite rightly) prepared to step outside their fiduciary duties to fix it.
Still, most of the managers surveyed had changed their behaviour – not because they believed in it but more because they were forced to. Among traditional managers, 61 per cent said they had been made to give up portfolio diversification and to avoid stocks they thought might outperform. But – and this is a very big but – the majority of both sustainable and traditional managers said that it wasn’t as a result of wanting to affect the cost of capital for firms, about having a positive impact on society, or even about constraints specific to their fund – but as a result of “firm-wide E-S policies”.
There are lots of caveats to these results – and the averages disguise significant variations. But the essence seems to be this: Most fund managers, however their funds are labelled, don’t consider E and S to be a top performance driver, and they “do not put significant weight on E-S objectives beyond what is required to improve financial returns”.
But look at the last bit of the survey – even traditional fund managers are already constrained by the “firmwide ESG policies” pushed on them by increasingly vast ESG departments. It isn’t in the label, sustainable or otherwise, where the real constraints lie, as the fund managers told Edman and Gosling’s survey; it is in their employers’ policies, which affect all funds. Look at it like that and it is obvious that rather than there being too little sustainable investing, there is too much. And if that is really the case, perhaps the FCA should be less worried about funds calling themselves sustainable but about apparently traditional funds caring too much about it. If you don’t explicitly ask for a sustainable fund, perhaps you shouldn’t end up with one.
