Four Counterpoints to ESG Investing Critics

The dramatic growth of sustainable portfolios has raised big questions for investors. Recent prominent media articles have warned of a bubble and criticized sustainable portfolios for being ineffective as agents of change. We think the critics have missed the point.

Sustainable investment funds are mushrooming. Assets under management in Morningstar’s global sustainable fund universe surged to $2.75 trillion at December 31, 2021, nearly three times the pre-pandemic level, according to Morningstar. Net inflows rose by 12% to $142 billion in the fourth quarter of 2021 from the third, while inflows for all funds fell by 6%. Asset managers have rushed to meet surging demand and to counter weaker flows of non-sustainable funds. In the last quarter of 2021 alone, 266 new sustainable funds were launched, bringing the total to a staggering 5,932.

Dramatic growth has attracted greater scrutiny. Recent articles in the financial media have argued that ESG investing is a bubble and doesn’t work. While investors deserve more transparency, and some funds undoubtedly fail to live up to their billing, many claims about sustainable portfolios are misleading, in our view. Here’s our take on four common critiques.

Claim: All ESG Funds Have Similar Objectives: Not true. Many critical articles and studies incorrectly assume that all ESG funds have the same objectives and follow similar processes. In reality, there’s a broad spectrum of approaches, from passive to active, and from diversified to single theme strategies. Some seek to only own “good actors” with positive social impact while others target “bad actors” to encourage positive change through active engagement. For some, ESG considerations are integrated with the sole intention of reducing risk, while others aim to tap attractive long-term growth opportunities. ESG investing isn’t a one-size-fits all approach and lumping all strategies together is misleading.

Claim: ESG Investment Is a Bubble: Has the flood of money into ESG funds in recent years created a bubble that is bound to burst? We don’t think the data support that view. While some sustainable (and non-sustainable) stocks trade at excessive valuations, they are a small minority of all ESG stocks. Within our global investment universe of more than 2,000 stocks aligned with the United Nations Sustainable Development Goals, only 7% currently trade at price to forward earnings ratios (for the next fiscal year) in excess of 50x, while 22% have single-digit P/Es. Regardless of how one defines bubble valuations, describing ESG investing broadly as a bubble is an overstatement, in our view. The Wall Street Journal recently wrote: “MSCI’s popular USA ESG Leaders ended 2021 with a forward price-to-earnings ratio about 6% higher than the broad index,”—perhaps a bit pricey, but hardly an ESG bubble by any definition.