It had looked like 2020 would be a big year for the ESG (environment, social, governance) industry.
Now the sole topic of conversation among investors is the financial carnage caused by the global health emergency.
Are ethical investing considerations a luxury in the current environment? Or is the current crisis proof that ESG issues are too big to ignore?
Covid-19 “reminds us that the natural world can surprise us, and very quickly”, Harvard economist Rebecca Henderson recently told the Financial Times.
The business of business is not merely business, she says. Investment managers cannot worry only about the health of the free market and hope that “someone else will take care of everything else”.
That's echoed by JUST Capital, which says companies need to do what they can to flatten the coronavirus curve, whether that is through paid sick leave and work-from-home policies or by providing leadership, as Louis Vuitton did by creating free hand sanitiser.
Investors are often surprised to see that technology giants like Apple and Microsoft feature heavily in ESG funds. It's often assumed ethical funds always exclude certain sectors, such as tobacco, oil, and arms among others.
Some certainly take this approach – Cantor Fitzgerald’s Green Effects fund, for example, only invests in shares on the 30-stock Natural Stock Index.
Most funds, however, opt for a policy of engagement. Instead of automatically excluding certain companies, they use their influence as shareholders to improve companies’ ESG policies.
Therefore, oil and gas stocks appear in the indices maintained by ESG index providers such as FTSE4Good, S&P Dow Jones, MSCI and Stoxx.
Certain funds, like Friends First’s Stewardship Ethical fund, combine these approaches. It conducts ethical screening and avoids companies with “damaging or unsustainable business practices”, while also engaging with less-than-perfect companies on how to improve their ESG practices.
As for returns, can investors do well by doing good or will plumping for ethical funds end up denting your net worth? Sceptics note that so-called sin stocks have traditionally outperformed; tobacco, for example, has historically been the best-performing stock market sector.
Advocates, however, argue it makes good business sense to stock up on socially responsible companies.
Indeed, increased urgency regarding climate change means some companies and industries will "fail to exist" if they don't change their ways, former Bank of England governor Mark Carney warned last year.
Both arguments may be flawed. Research from fund group Robeco suggests certain sin stocks have done well because they were highly profitable, high-margin businesses.
Ethical investors could do just as well if they screened for similarly profitable stocks in other sectors.
That said, the argument that you will outperform by buying ‘good’ companies may also be weak -- some may be worth it, some may not. Most experts agree that anything that restricts your investing universe could hamper your returns, although research from fund group GMO suggests removing one sector – for example, oil – from your portfolio will make little difference.
Overall, however, ESG investors are unlikely to pay a price for their principles. Deutsche Asset Management analysed 2,200 studies on the subject and said 90 per cent found that ESG investing didn’t hurt returns.
Conscientious investors who want to earn the best possible returns may prefer funds that opt for engagement over divestment.
London Business School research shows that when institutional investors persuade a company to improve ESG practices, its financial performance improves and its stock price gains. Moreover, a 2019 Bank of America report found that firms involved in 24 ESG controversies lost $534bn in market value.
Finally, it’s worth remembering that costs are the biggest determinant of investment returns – hefty annual fund fees can seriously hurt long-term returns.
Exchange-traded funds (ETFs) tend to be inexpensive and investors shouldn’t have much difficulty finding specific ETFs that matches their particular area of interest, whether that’s green energy, water management, gender diversity or anything else above the ethical water line.
Alternatively, investors may prefer a broad fund offered by an ESG index provider. One is Vanguard’s SRI (Socially Responsible Investing) Global Stock Fund, which contains over 1,800 companies around the world.
The annual fees with this fund are almost identical to Vanguard’s non-SRI global stock fund, notes Dublin-based Moneycube, and returns have only slightly trailed its non-SRI counterpart over the last three- and five-year periods.
Whatever fund you are considering, be sure to check under the hood and see what stocks you’re buying.
Different funds take different approaches, and ethics are very much in the moral eye of the beholder.
How green is Tesla?
Electric car maker Tesla is one of the top car manufacturers in the world when it comes to ESG (environment, social, governance) criteria, according to MSCI. No, it's not, says FTSE – it's the worst. Actually, they're both wrong, says Sustainalytics – Tesla is pretty middling.
When credit rating firms assess companies’ creditworthiness, their ratings match 99 per cent of the time. However, research indicates that when ESG rating firms assess companies on ESG matters, their ratings only match 60 per cent of the time.
The problem is there are no agreed standards as to what constitutes good ESG. Accordingly, Tesla got a near-perfect score from MSCI for its environmental performance, but FTSE gave Tesla a zero score on the environment because its criteria is different.
The lack of standardisation in ESG data means some companies may think: why bother trying to improve our ESG score if our efforts aren’t rewarded by certain rating firms? Others may try to game the system via superficial green-washing activities. All of this is far from ideal for investors. Differing definitions of sustainability means they don’t know quite what they’re getting with many ESG funds.
Equity “punks” fund BrewDog’s expansion
Is it ethical to invest in a beer company? Fast-growing Scottish craft beer producer BrewDog likes to think so. The company has expanded over the years by raising over £75m through its Equity for Punks crowdfunding scheme, directly appealing to its customers to fund its growth and put “the fat cats out to pasture”.
BrewDog’s beers have included Make Earth Great Again, a protest beer “to remind global leaders to prioritise issues relate to climate change”, the proceeds of which were donated to a climate change charity.
In 2017 BrewDog launched its Unicorn Fund, promising to give away 20 per cent of its profits annually – 10 per cent to staff members and the other 10 per cent to charities chosen by staff and its “equity punk” investors.
The plan would benefit BrewDog as well as charities, said the beer company's co-founder James Watt, as it would likely "increase our sales as consumers more and more want to buy from socially responsible companies".
Still, sceptics can always return to their core question: is it really that ethical to invest in a beer company?
Seeking a quick buck in green bubbles
You might choose to invest in sustainable stocks because you want to save the planet. Alternatively, you might do it because you simply want to make a quick buck.
Take plant-based meat alternative company Beyond Meat, whose early backers included actor and climate change activist Leonardo DiCaprio as well as Microsoft co-founder and philanthropist Bill Gates. The company attracted a completely different sort of investor after going public last May.
After setting an initial public offering (IPO) price of $25, demand from excited momentum investors saw the stock open for trading at $46 (€ ) and hit an opening day high of $72. By July, it had exceeded $239, but the bubble inevitably burst and it’s been downhill ever since, with the stock losing three-quarters of its value.
Beyond Meat may well have a bright future, but valuation matters – a great company isn’t necessarily a great stock.
Both JPMorgan and Schroders have cautioned about the possible formation of green bubbles, the latter saying that it has “respect” for ESG but warning that managers should be “very careful” not to put investors’ money into bubbles.
The Greta effect
The global influence of Swedish environmental activist Greta Thunberg has been dubbed the 'Greta effect'. Unsurprisingly, it's also evident in the finance industry, says London-based Last Word Research.
It notes that in 2018, 35 per cent of fund selectors in Europe and the UK said they would eventually stop using a fund group if it did not engage with ESG, but this number shot up to 59 per cent in 2019.
Research from fund group Morningstar shows that net flows into ESG funds was relatively steady between 2016 and 2018 before suddenly quadrupling in 2019.
According to a global survey carried out by the deVere Group, 77 per cent of millennials cite ESG investing as their top priority when considering investment opportunities. Greta Thunberg is, says deVere Group chief executive Nigel Green, “reshaping the global investment industry”.
Our definitive Top 1000 companies guide, published with The Irish Times on Friday, June 12th, is also available at irishtimes.com/top1000