ESG (Environmental, Social and Governance) investing has been in the news a LOT lately! A huge cynic would say ESG investing is just another money-making scheme made up by Wall Street to sell something “New & Improved” to an unsuspecting public. A die-hard “tree-hugger” would say it is about time that we “vote with our dollars” on companies that “Do Good”. Or, as reported in a recent article quoting Larry Fink, CEO of Blackrock, anything related to climate change or other ESG-issues is simply an investment risk that needs to be part of the investment analysis equation. As is almost always the case, the real truth lies somewhere in the middle of this discussion.
ESG investing strives to limit investing in companies that do not follow a collection of current views on such topics as global warming, pollution, equal rights, board composition, and other things. The idea is that if investors stay away from those companies, then their share price will fall and their corporate debt will be more expensive to issue and they will thus be forced to change their corporate behavior to a more ESG-friendly approach.
Most of the large investment firms manage mutual funds or ETFs that tilt their style to accommodate ESG considerations. For example, Blackrock manages an ESG-Screened ETF (XVV) that filters out companies viewed as not ESG-friendly. Out of the top 25 holdings, the major exclusions are the oil companies Exxon and Chevron due to climate change concerns. See the chart below that shows the S&P 500 (IVV, the blue line on top) performance from September 30, 2020 (its inception date) compared to the S&P 500 ESG-Screened ETF (XVV). They both tracked together fairly closely over time, but the cumulative total return of the S&P 500 (IVV) was +22.19% beating the +18.69% for the ESG-filtered (XVV).
The trouble with this analysis, however is that there is no hard and fast rule on what qualifies as “ESG”. If you do a Google search on ESG investing, you will find a multitude of ESG “scores”; each claiming to be the definitive measure of ESG strength. For example, Tesla, the electric car company, has an ESG rating of “Medium” from Morningstar, but was recently excluded from the S&P ESG index due to S&P’s proprietary measure of Tesla’s weakness on social and governance issues. So, one man’s treasure is another man’s trash.
At D&A, we agree with Larry Fink’s view that all investment risks need to be considered within the context of creating and managing an investment strategy. D&A’s focus on a portfolio of high quality investments managed to an appropriate overall risk target, implicitly reflecting any ESG risks, is designed to help you achieve your goals.