It's been trending for a few years now as generational shifts in demographics herald new marketing trends, but it's recently come under fire from various quarters. What exactly is "ESG" investing?
The problem is, no one knows. Or maybe everyone knows. And everyone believes (very strongly, by the way) that it is something else.
"As with many other investment strategies, one of the problems with ESG investing is the lack of agreement about what it is in theory and in practice," says law firm director Albert Feuer. Albert Feuer in Forest Hills, New York. "There is no agreement on what terms ESG Investing refers to. Some refer to environmental, social and governance factors. Others refer to environmental, stakeholder and governance factors. Regardless of the definition used and the individual factors chosen or emphasized , ESG investing is nothing more than using these factors to determine whether to acquire, dispose of, or how to dispose of ownership rights in a company. There is also no agreement on how investors should use these factors Focusing on these factors, like any investment factor, can only aim to improve financial returns, for example by better assessing their impact on business performance.
On the other hand, as with many investment strategies, the truth is in the eye of the beholder. Just as some investors prefer 'Growth' to 'Value' investing and others prefer 'Value' to 'Growth', some investors may see a role for ESG (however defined) while others do not.
"ESG is not a comprehensive strategy, but it can be used as a factor in developing an investment strategy," said David Blaylock, manager of financial planning at Origin in Dallas-Fort Worth. “For example, an individual's investment strategy may be to reduce risk, and considering business risks on the ESG front can help achieve the objective of the investment strategy. To mark this as an investment strategy, it is expected to see an impact in the mentioned areas. By the way, we don't see how this type of investment (eg ESG) has anything to do with anything other than utilities.
"Better assessment of the impact of climate change on different businesses would be another example," says Feuer. “However, ESG investing, like any strategy, can be measured simply by looking at risk-adjusted or absolute financial returns over an appropriate time period. Focusing on these factors can partially contribute to improving the performance of companies in relation to these factors. This can (but should not) be at the expense of financial income. In such a case, it is reasonable to ask whether these ESG performance measures are the main reason for considering such measures. For example, if the goal is to improve workers' compensation, the measure may be limited to workers' compensation or extended to all employees associated with the business, such as independent contractors or business associates of the company.
The increasing use of ESG as a moral standard makes matters worse. This allows discipline to enter the realm of partisan glory.
"One of the many challenges preventing widespread adoption of ESG in defined contribution schemes is the overtly politicized nature of ESG, as evidenced by unwelcome changes to the DOL's regulatory guidance whenever a new political party takes control of the House White," said Christopher. Jarmusch is senior vice president and chief investment officer at Gallagher Fiduciary Advisors, LLC in Washington, DC highly polarized (and controversial) environment."
In many ways, when "ESG" was more narrowly defined in the 1980s than "SRI" ("Socially Responsible Investing"), it was easier to isolate these investments (and the nature of their returns) because the boundaries of SRI are generally . : was quite specific. .
"The change in vocabulary from 'socially conscious' to ESG has rendered the concept almost meaningless," said Peter Nero, chief compliance officer at MM Ascend Life Investor Services, LLC in Cincinnati. "Where some funds have classified themselves as 'socially responsible', they have clearly stated in the fund's objectives the types of companies they would invest in and the types they would avoid. There is no such clarity with the ESG rating. "
ESG skeptics in the investment industry often ignore the politics and focus on the numbers.
"ESG opponents often point to small differences in portfolio holdings (compared to their underlying index fund counterparts) while pointing to large differences in fees," says Jarmusch. "The claim is that ESG funds are nothing more than colored wallets sold at Picasso prices. As is often the case in fashion, it was a boom for Wall Street and a boom for Main Street. .
Several media outlets have recently noted that funds purporting to focus on "ESG" factors have significantly underperformed during market downturns. This poor performance may be more than the article titles suggest. By the way, the same can be said about the apparent excess of these funds.
"The short-term investment performance of any market sector is almost meaningless," says Michael Edeses, Managing Partner/Special Advisor at M1KLLC in Hong Kong. "The underperformance of ESG funds may be a continuation of their past performance due to their cash inflows (I avoid using the term 'mean return' as it is misused and misunderstood, but in this case, explanations can help you).
However, even the short-term underperformance shows a small crack in the ESG wall. Proponents of this approach often argue that investing in ESG factors won't hurt money. (Those in the know will recall that Trump told the DOL that pension plan administrators should always make monetary factors a top priority when choosing plan investments.)
"It is clear that although ESG funds have underperformed this year, they will significantly outperform in 2020 as the energy sector is underrepresented in most ESG strategies," said Brendan Sheehan, Director Manager of Waymark Wealth Management in Marlborough, Massachusetts. "So when energy fell -33.7% in 2020 versus +18.4% for the broader market, ESG strategies performed significantly better as many did not hold up to energy stocks. On the other hand, as of June 30, 2022, the energy sector grew by +31.8% compared to -20% for the overall market ESG funds do not benefit from exposure to this high performing sector.
The potential for significant underperformance resulting from strong sector underperformance has been the traditional scourge of SRI funds for decades. It would be foolish to think that ESG funds will not suffer from the same disease.
"ESG funds have underperformed this year because they have deliberately avoided fossil fuels and commodities, which hold up well to high inflation, and have leaned heavily on growth stocks, such as technology, which hold up well to inflation. high," says Jeremy Bohn, financier. advisor and founder of Paceline. . Wealth Management, LLC in Boston. “In this environment, strategies that invest only in companies that are leaders in corporate governance in their sectors can have very different results than those that eliminate entire sectors of the economy because of what they do.
You begin to see that ESG investing requires a level of excellence not typically found among ordinary workers.
“All 401(k) members are contributors; many of them are sophisticated investors," said Jack Tawarnicki, attorney at Koehler Fitzgerald LLC in Powell, Ohio. "401(k) members are best characterized by their diversity: ages 18 to 100+; young employees with over 50 years of experience; high school dropouts for those with PhDs. or professional degrees (JD, MBA); individuals making their first contribution to lifesavers. Another distinct feature confirmed by S&P Global Financial Literacy Survey and the TIAA-GFLEC Institute Personal Finance Index is that participants are not ready to become investors.
This is where successful ESG marketing efforts can hurt naive retirees.
The ESG phenomenon may simply be "an acknowledgment by investors that they feel good because their investments are improving the world we live in," said Ron Surtz, host of the Baby Boomer Investment Show in San Clemente, California. "You don't need lawyers for a good investment. ESG is a game built on people's desire to do good."
If so, and if today's health investments can lead to tomorrow's "wellness" retirement, what can today's 401(k) members do to learn how to resist the pull of "wellness" investments?
"How Does a 401(k) Participant Work?" Tavarnitsky asked. "That's gallows humor, isn't it? Answer: Most don't, and most won't. create 401(k) investment rules. Participants know it. Trends in 401(k) investment activity increasingly reflect inertia or participatory learning, or perhaps a little of both. 2 million 401(k)s with more than 200 billion in assets to operate by early 2022 An August 2022 report on investment activity among over 100,000 participants (during the market downturn carried over) showed that less than 1% of participants changed their investment compensation.!”
why Towarnicky notes two obvious trends.
"First," says Tawarnicki, "the average tenure over the past five decades has been less than five years, so more than half of active participants have less than five years in their 401(k); , the impact of disproportionate current ESG Investing There is a clear difference with most 401(k) plan investors, as the main argument in favor is what is called the “long-term interests.” of 2006 for asset allocation in 401(k) plans, Researchers of The Employee Benefit Research Institute and the Investment Company Institute never mentioned the words “target date.” The plan included target date funds in their list of investments…31% of assets…(low) 60% of 401(k) plan participants had…target funds". In 2022, these percentages are likely to be higher!"
Towarnicky, "participants voted with their investment 'feet' and chose not to make investment commitments."
That's why you see 401(k) plan sponsors as the first line of defense in investor protection. They don't want to give workers enough rope to send their pensions up the gallows, as Tavarnicki calls it. On the other hand, they don't want to completely prevent employees from making their own decisions.
"In my role as a member of the investment committee for my Fortune 100 employer's 401(k) savings and retirement plans, a smart acting friend told me long ago, “Over time, bulls win and bring money, and chickens make and keep money. the pigs are killed. ", – says Tavarnitsky. "I have learned that there is only one option to ensure that participants avoid 'following the crowd' and/or 'aim for the fence' behaviors when choosing ESG, cryptocurrency and other similar investments: don't offer them options as their primary investment. ..limit them to one referral brokerage account. However, such 'success' may be short-lived if 401(k) assets end up in self-directed IRAs."
You control your retirement investments. Be careful of letting someone make an embarrassing statement today, because you may unknowingly pay for it tomorrow in retirement.