The Perils of ESG Investing

It can often seem as if nearly every major party in Western democracies is fighting to prove their green credentials and come up with a snappy plan to combat climate change.

While forests burn and ice caps melt voters are coming around to the centrality of the climate change issue. Politicians are therefore unsurprisingly trying to co-opt this newly mainstream political territory for their own purposes.

Small and large, right and left, establishment and rebels, all parties seem to be trying to make green political themes align with their policy preferences and ideological leanings.

As we have tried to suggest before, the rise of a powerful and politically broad environmentalism is both a very welcome development and one to watch - as investors and citizens - with great care.

The fear is that both the great difficulty of combating change combined with some of the inherent qualities of the challenge and some rather aspects of human nature, could create a lot of rather obvious mistakes which would then lead to disappointment and eventually disillusionment and rejection.

Thus, the very popularity for environmentalism today could, paradoxically, create the political space for anti-green politics tomorrow.

An anti-green political force is the last thing we can allow to germinate. We must avoid this cynical scenario at all costs.

The danger is that populism, conspiracy theorists and cunning political opportunists thrive in democracies when, for whatever reason, complex problems get bungled and the perceived costs get passed down unevenly and arrogantly onto certain groups.

No one likes being shamed. People like being shamed even less when they are being taken advantage of.


As we detailed in an earlier edition of Pebble, there are three broad reasons that make a broad turn to combating climate change very tricky and even treacherous, politically.

  1. First off, it requires immediate and very real sacrifices in return for only very distant rewards. Its complexity also requires relying on technocratic "experts" with all of their attendant problems.

  2. It is a collective action problem. We all must act together to be better off but many of us have different (and conflicting) self-interests. Rich countries (or people) have benefited from the carbon heavy economy already. Others have not. This creates a natural tension that will be difficult to resolve.

  3. The definition of what is "green" is very slippery. We may paradoxically use more of a substance as it becomes more efficient. This phenomenon is known as the Jevons paradox and plagues efforts to combat climate change.

These challenges need to be confronted, not wished away or, even worse, cynically exploited by the political class and elites at the expense of broader society and especially regular people.

Exploitation will only encourage anti-green politics to develop and gain traction. It will also raise the total cost for tackling climate change.


Okay, can you give a concrete example of this?

Absolutely! Here is a great and recent one:

In July, Morningstar, the fund rating company reported that 25 US funds had rebranded as "sustainable" in the second quarter of 2021.

These funds promised to invest their funds in companies that score highly when measured against various Environmental, Social and Governance (ESG) metrics.

This is a growing trend. Morningstar has found that since 2013 there have been 64 such revamps in the US and an order of magnitude more in Europe, where ESG investing is even more popular.

Okay, what is the catch?

Well the catch is twofold:

  1. These funds are charging high fees and not necessarily earning them by outperforming the market.

  2. How "sustainable" are they anyway?

There is a world where, at the risk of being overly cynical, these are NOT funds seeking to provide investors who are interested in more values based investing with better products.

Rather, they are simply poorly performing active managed funds that are looking to rebrand as "ESG" and surf the wave of popularity so they can avoid fund outflows and make higher fees than they otherwise would.

This is a problem and borderline exploitative.

In case our argument seems harsh let's turn to that data. Morningstar was less outspoken than we are but another analysis of these 64 funds found that, in the preceding years, 35 of the 64 were experiencing fund outflows.

They were funds that were not doing well and investors were rightly punishing them. Faced with the possibility of closing down they have instead chosen to "rebrand" as the latest trend and allow their high fees - and very likely - their awful performance to continue.

So? What can a regular person do about this?

  1. Be very careful about the funds you invest in. Do your research.

  2. Be mindful of those fees, always. What are you getting for your hard earned capital? Even basic googling can reveal a lot and might surprise you quite a bit.

  3. Lastly, if you are passionate about this type of investing, ask yourself whether any company or fund is truly sustainable, not just for the planet but also as a business. Many businesses are good at being a business or being sustainable, finding truly excellent exceptions is very challenging. What does your ESG fund own?

It is still early for ESG investing, frankly. And we worry that the industry's failures will be another (small) cynical contributor to the rise of an anti-green politics.

For now, these challenges will hopefully get easier as the transition to a carbon free economy gathers steam and anti-green politics stay dormant. Stay positive!

The difficulty of being both superbly sustainable AND a great business brings us to....


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