The High Growth of ESG Investing can Reduce Adherence to Principles
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ESG Investors Who are Concerned About Environmental and Social Impact Should Closely Watch Their Investments
ESG funds received double the amount of money in 2020 than they did in 2021. Funds that say they use ESG principles or Environmental, Social, and Governance to dictate their investment universe captured $51.1 billion in net new money from investors in 2020. This is the fifth year in a row this subset of funds has set a record on higher net increases.
Since the start of 2019, stock mutual funds and stock ETFs with ESG as part of their selection process have received a net $473 billion from investors. To illustrate how big this is, only $103 billion has gone into all other stock funds. With all this new money entering ESG funds, some companies are inclined to “paint themselves as green” in order to get investor attention. Some fund managers flush with new cash may be inclined to stretch their definition in order to keep fully invested.
Two Types of ESG Investors
There are two primary types of ESG investors, those that are very concerned for the environment and hold certain social beliefs dear, and there are those that want to ride the wave of a trend that has a great deal of money chasing it. For those trying to capture a trend, ETFs and mutual funds geared toward this label may make sense. For investors truly concerned about the environment, and would like to be more sure companies they own behave in ways they deem important, they may wish to create their own portfolio. In this way, they can be more intimate with each company they decide to own.
In 1990 the mutual fund company I worked for opened one of the first social choice accounts. The idea was that it would support investments that "did good" and shun those that caused harm. Many of the environmental guidelines are similar to todays’ ESG funds; back then, we also eliminated any investments related to apartheid South Africa and required adherence to the MacBride Principles in Northern Ireland. As I recall, we screened to make sure there were no tobacco, alcohol, or firearms related companies. As a new fund, it was seeded with a $200 million investment from an existing large fund we managed. When a new fund is seeded, before investors arrive, the investments are kept somewhat liquid and low risk as the money needs to be returned to the sister fund. My role was to invest this money, initially, it was expected to be placed in U.S. Treasury Notes. The problem I had with this is I read the prospectus, and within it was language that suggested that issuers that produced or were in the business of funding firearms were to be excluded. Certainly, the U.S. Treasury as an issuer fell into this category. Long story short, we made an exception—one of many exceptions we made for that fund over the years. With little competition for suitable companies, we broke our own social guidance on day one.
A story in this past Friday’s Wall Street Journal highlighted an entrepreneur whose company, which mined the sea floor, went broke as the local government cracked down on his mining of the sensitive seabed. The same entrepreneur has recently gotten back into the business of seabed mining, but this time positioning his new seabed mining venture, The Metals Company (TMS), as green, to attract capital during this surge of environmentally steered funds.
TMC is likely to receive approximately $600 million in investor cash in a deal to take the company public in July. If successful, that would value TMC at $2.9 billion—more than any mining company ever to go public in the U.S. with no revenue.
This is one example where a company that produces something for one green industry may not produce it in a way that would make environmentally-minded people comfortable. But fitting an ESG definition at times is all that is needed to attract capital from large managers.
Alternative to Funds
Investors that are drawn to this category, particularly with the demands placed on fund managers inundated with cash and searching for value in trading-lot sizes of $1 million or more, may want to rely on their own evaluations. Technology has changed and makes this easier and more cost-efficient than ever before. We are lucky to have a trading environment where transactions are essentially free, fractional shares are available at many brokers, and access to company information is at your computer screen.
Individual investors have a true advantage over a large fund manager in that most funds will have withdrawals when the market is down and investors are frightened, and they will get untimely deposits when the market is up. They are often forced to buy high and sell low. Individuals are not forced to but or sell, nor are they held to maximum percentage cash restrictions. They are also more nimble. With all the money flowing into the sector, investing in a retail size block compared to an institutional size block gives you more pricing power than the big guys.
Let the buyer beware especially applies to ESG funds today. There are companies that are reinventing themselves as green that may not fit other definitions, and there are fund managers that are being inundated with cash looking for value in with large trades.
Investors can use their free online trading, and free top-tier research and data from Channelchek and other sources to evaluate companies themselves and weigh them against their own heart.
Managing Editor, Channelchek
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