ESG investing heading for a reckoning, says veteran manager

THE ESG investment industry may be headed for a reckoning, and many companies won’t survive this period of higher interest rates.

So says James Penny, who has been running ethically focused funds for about a decade and is currently the London-based chief investment officer at TAM Asset Management. (ESG stands for environmental, social and corporate governance, an approach to evaluating the extent to which a corporation works on behalf of social goals that go beyond the role of a corporation to maximise profits on behalf of the corporation’s shareholders.)

He predicts that several companies owned by ethically focused funds will struggle to refinance their debt, but did not name specific firms. 

“A lot of ESG companies out there that probably can’t survive with interest rates going where they are,” he said in an interview. “There will be ESG companies that will go to the wall because of this market.” 

It’s the latest in a string of warnings to hit the ESG space. The investing style rode out the pandemic better than other corners of the market, but is now coming under pressure from higher inflation and interest rates. It’s been particularly punishing for technology stocks, a staple of ESG funds. 

For fund managers, the period ahead “could be like a baptism of fire”, Penny said. 

There are now signs that interest in ESG investments is flagging. After more than 3 years of inflows, stock investors pulled about US$2 billion from US exchange-traded ESG funds in May, the biggest monthly redemption on record, said Bloomberg Intelligence. 

Meanwhile, the Impact Shares MSCI Global Climate Select ETF is set to close after less than a year because none of the backers pitched in with anticipated funding.

The tougher market environment for ESG has coincided with growing disillusionment. Insiders such as activist hedge fund boss Chris Hohn have publicly lambasted the way in which much of the asset management industry does ESG, characterising it as toothless.

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And according to a recent survey conducted by the Journal of Financial Planning and the Financial Planning Association, there are signs of a broader cooling under way in sentiment toward ESG. The investment model “may have reached an inflection point”, the groups wrote in a statement.

“It’s the environment that’s causing ESG stocks to underperform, but it’s also sentiment causing ESG stocks to underperform,” Penny said. He added that ESG fund managers need to be more selective and come up with “a full suite of different investment strategies” rather than rely on a limited number of asset classes. 

TAM Asset Management has been working on diversifying. The goal is to find ethically sound investments that are uncorrelated, which could include dividend paying stocks, property, infrastructure or funds with an overweight to health care, he said.

TAM is tilted towards quality and value, but still has exposure to growth stocks in its ESG strategies, Penny said. Ultimately, the goal for investors right now is not to lose money, he added. 

“You’ve got this broad-based sentiment turning against even high-quality companies,” he said. “People are just very fearful.”