Does ESG investing increase returns?
The evidence on investment returns is more ambiguous — some studies find the stock prices of companies with high ESG ratings outperform, but others find no measurable effects, and some even document lower monetary returns.
Globally, ESG Leaders earned an average annual return of 12.9%, compared to an average 8.6% annual return earned by Laggard companies. This represents an approximately 50% premium in terms of relative performance by top-rated ESG companies.
ESG funds have similarities to other funds
While the results from these time periods have been generally encouraging for ESG funds as a whole, we don't see convincing evidence that ESG funds are reliably better than non-ESG funds.
Until recently, investors were pouring money into ESG and sustainability funds — roughly $20 billion in 2019, $50 billion in 2020 and $70 billion in 2021, said Alyssa Stankiewicz, who researches ESG funds at Morningstar. And during that period, ESG actually generated better returns than traditional investments.
If the market is placing a higher premium on good ESG stocks than on bad ones (meaning they're priced higher and then returned less), thus creating an ESG risk premium, we would expect the return on the overall portfolio to be negative on average.
In contrast to much of the positive reception ESG has received, some evidence suggests that it isn't even offering financial benefit for investors and businesses. A study conducted by researchers at the University of Chicago found that high sustainability funds hadn't outperformed any of the lowest rated funds.
In some cases, ESG has outperformed, while in others, it has underperformed. Figuring out whether ESG stocks outperform the broader market is difficult for a few reasons. For one, there isn't a central authority that can decide whether a business follows ESG practices.
Critics of ESG — such as a group of Republican states that banned Blackrock and other “ESG friendly” asset managers from their state pension plans — argue that considering environmental and social factors violates the fiduciary duty that asset managers have towards their clients.
However, there are also some cons to ESG investing. First, ESG funds may carry higher-than-average expense ratios. This is because ESG investing requires more research and due diligence, which can be costly. Second, ESG investing can be subjective.
A lot of their underperformance is thanks to missing on just a handful of tech stocks, according to a report from Morningstar. Last year, 82 out of Morningstar's 146 sustainability indexes underperformed their non-ESG equivalents, making 2023 the second worst performing year on record, after 2022.
Is ESG on the decline?
As ESG flow momentum declines globally, regions like Europe and Australia have still been able to maintain positive numbers. In Australia, over $760 million flowed into ESG ETFs in 2023. However, other nations, including the US, have been shunning ESG ETFs, leading to billions of dollars in net outflows in 2023.
89 percent of investors consider ESG issues in some form as part of their investment approach, according to a 2022 study by asset management firm Capital Group.
These days, ESG investments have lost their luster given high interest rates, political backlash, and greenwashing scrutiny.
Investors increasingly believe companies that perform well on ESG are less risky, better positioned for the long term and better prepared for uncertainty. Companies that realign to the stakeholder capitalism agenda may have a competitive advantage over those that try to return to business as usual.
In December 2022, Florida announced that it was taking $2 billion out of the management of BlackRock, the world's largest asset manager (and biggest lightning rod for ESG criticism). This was the largest such divestment thus far. These attacks have been coordinated.
Ironically, viewing sustainability through an Environmental, social, and governance (ESG) risk and financial materiality lens still systematically underestimates future financial risks and fails to identify emerging opportunities. Data and information being used to make decisions is not decision useful.
Environmental and societal issues, such as climate change, biodiversity loss, modern slavery, inequalities, food security and others are interconnected and lead to risks and opportunities for both, businesses, and society.
ESG investing's dark side threatens to undermine clean-tech strategies amid ravenous demand for metals: 'We should be under no illusion' Wind turbine manufacturers and EV makers are “massively exposed” to the systemic risks that stem from the link between mining and the clean-energy industry.
Despite the recent challenges, ESG investing is likely to remain a trend in the years to come. As investors become more aware of the environmental and social impacts of their investments, they are increasingly seeking out investment products that align with their values.
Myth 1: ESG investing will have a significant impact on my returns. The facts: Northern Trust research finds that ESG funds do not perform better or worse than other managed non-ESG funds on a risk adjusted basis. Some investors assume ESG investing means sacrificing returns.
Does ESG investing lower returns?
ESG assets have higher valuations today if their systematic risk is reduced, and therefore they should have lower expected returns for investors in the future. Investors hold ESG assets because they hedge climate and social risk.
Many academic studies and observations from market practice suggest a positive relationship between ESG and firm value and profitability. However, there are also quite a number of negative and mixed results in previous research.
Risk Mitigation: Companies with strong ESG practices are often better equipped to navigate environmental challenges, social unrest and regulatory scrutiny. This translates to less volatility and potentially higher long-term returns for investors who prioritize stability.
ESG Large-Blend Equity Funds Bounce Back From 2022′s Lows
In 2023, both sustainable large-blend equity funds and conventional peers lagged the Morningstar US Market Index, but the median shortfall was smaller for sustainable funds than for conventional peers.
The global ESG and sustainability reporting focus is shifting from being largely voluntary to a mandatory disclosure landscape. Underpinning this shift is a patchwork of global regulations with various environmental, social and governance (ESG) disclosure requirements.
