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Many investors come to advisors looking to align their investments with their personal goals. Advisors often point them in the direction of environmental, social and governance (ESG) investing to align the seemingly dichotomous principles of “making money” and “doing good.”
But doing good is an individually determined value and impossible to define in a blanket statement.
ESG proponents sell the idea to investors that they can achieve both altruism and high returns. In the end, they fail at both, with for example Blackrock’s ESG flagship fund ESGU down 20% in 2022 and including holdings that did not fall into the ESG bucket like AAPL, AMZN, GOOG, KO, XOM to name a few.
However, large ESG funds don’t capture individual preferences. Buying so-called ESG funds and entrusting good returns will follow and objectives are fulfilled has been a fool’s errand. The harder, more precise way is for advisors to help their clients select specific investments that match their personalized definitions of doing good.
Instead, in an effort to offer universally good stocks in a basket of securities, ESG proponents have created a one-size-fits-all product for investors, herding them into the same stocks under the guise of delivering on ESG objectives when the funds offer lower returns.
Four of the top five stocks in the SPY, QQQ, and ESGU are the exact same: AAPL, MSFT, AMZN, GOOGL. Notably, in 2022 SPY was down 18.14%, QQQ was down 32.49% and ESGU was down 20.22%. Similarly, the S&P 500 was down 19.4% and the Nasdaq 100 down 33.1%. Because the research and rating agencies behind ESG have been inconsistent and conflicted, non-ESG investments have ended up in ESG funds. A team of researchers at MIT called ESG “aggregate confusion.”
Many investors want to avoid companies with big carbon footprints. However, they fail to recognize that companies like Amazon are leading the world in carbon emissions.
Just because a company is ESG friendly doesn’t mean that it doesn’t contribute to societal ills. Those concerned with the cost of type II diabetes – some $260 billion in the U.S. as of 2016 – and the obesity epidemic might argue that a socially conscious investor cannot own Coke or Pepsi, two more darlings of the ESG world – and the top holdings in Nuveen’s large-cap ESG fund.
The challenge for investors and their advisors is in customizing and tailoring portfolios. The easy yet inefficient and ineffective way to gain ESG exposure is to buy a generic ESG fund from the industry behemoths. But products and investment managers are focused on asset grabs, not the principles of ESG.
Investors need to refocus and maximize gains by finding superior risk-adjusted return opportunities like sectors under capital constraints that have been excluded from the explosive ESG investing bubble. Hedge fund legend Cliff Asness wrote about this, citing these constraints that cause misallocation of funds and malinvestment that in turn yields high expected return securities in the maligned sectors. These include things like the ESG orphans, the exclusions from the ESG bubble that felt the brunt of ESG imposed capital constraints.
When investors are successful by maximizing returns, doing good in the real world gets much easier. The onus is on investors to do their due diligence and dig deep to ensure invested dollars clearly focus on specific investment objectives, rather than relying on trends and buzzwords that sound much better than they are. Those buying ESG funds to simply check a box will find themselves not achieving ESG objectives nor getting great returns.
Buying into the ESG narrative, laden with ulterior motives under false equivalences, sets investors up for failure. The five-year annualized returns for ESGU trailed the SPY by 0.20% while annualized volatility exceeded the SPY by 0.50%. Meanwhile, fees in the ESGU are 57% greater than the SPY.
Investors need to seek the truth and invest in what they know and can control by taking a closer look at their investments and holdings within funds and be prudent stewards of capital to focus on returns. Then they can do good with their hard-earned gains by donating to causes important to them, spending time volunteering, and advocating for ESG causes having a more direct impact.
Mark Neuman is founder and CIO of Constrained Capital and creator of the ESG Orphans Index and the ETF ORFN. He began working with pension funds, hedge funds and mutual funds with Merrill Lynch Japan in the 1990s, by designing portfolios to help them manage risk using derivatives. He also has experience using futures and options, as well as creating baskets with factor-driven themes. His experience predated ETFs but allowed him the opportunity to learn about the construction of funds, by assigning portfolio allocations based on specific expected outcomes based on these factors. He returned to New York with Merrill Lynch and worked with the portfolio trading desk to discuss client-driven solutions in helping them come up with new ETF themes. As a CFA charter holder, he spends time helping investors manage risk and spot opportunities. He created strategies that capitalized on the best way to express the view by employing futures options or ETFs.
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