Environmental, Social, and governance (ESG) investing has grown into an extremely popular investing style over the past few years. And rightfully so, since so many individual investors care about where they are putting their money and how the companies they invest in behave from an environmental, social, and governance standpoint.
Many also believe that ESG investing is the best way to change the thinking and actions of those in charge of large corporations since they may be excluded from funds and large investments if they are not meeting the ESG standards. This, although yes yet to truly been seen, take place since ESG investing is still relatively new.
Many investors would also say that they have been investing with an ESG mindset for decades; they just didn’t call it by its current name. For example, my own wife refuses to buy stock in alcohol, tobacco, firearm, casino, or marijuana companies due to her beliefs and doesn’t want to support those types of businesses. But, on the other hand, I have no problem investing in those types of companies as long as they are well-run businesses that are abiding by the law. So, everyone has their own opinions about ESG businesses and funds.
However, if you want to only own ESG funds, you need to understand that these funds may be costing you money in the long run. Before we get into the way they may be costing you money, I want everyone to understand; there is nothing wrong with sacrificing potential gains to support the types of businesses and leaders you believe in. It really is no different from, say, someone investing in bonds instead of stocks because they want to take on less risk and realize lower returns. The important thing is that you fully understand the risk and rewards of investing in ESG funds.
First, on average, an ESG Exchange Traded Fund will have higher fees associated with the fund than your typical U.S. large-cap ETF. On average, ESG fees were 0.20% at the end of 2020, while the average U.S. large-cap ETF had a fee of just 0.14%. That is a 43% difference in the fee that you are paying for the ESG ETF. That is not a huge difference, but that 0.06% will add up over time, especially if you have a sizeable account.
Then there is the issue of what companies or industries you may be forgoing by only investing in ESG stocks. As my wife and I have talked about, she is perfectly fine missing out on the returns that’s can be had from the “sin” stocks. However, not everyone knows the returns that some sin stocks have produced over the years, so let me share. It is estimated that California has forgone $3.6 billion in investment revenue for its state pension plan due to not investing in tobacco companies since 2001. Again, I fully understand that some people don’t want to invest in things like tobacco.
But, did you know that the best-performing industry, by a very long shot, from 1900 -2010 was (yes, you guessed it) the tobacco industry? $1 investing in the tobacco industry in 1900 was worth $6.3 million in 2010, while the average US industry turned $1 in 1900 into $38,255 by 2010. Quite a big difference in returns.
Another issue worth pointing out is that the Securities and Exchange Commission (SEC) released a statement in April 2021 which stated that it had seen several asset managers who have been misleading investors with marketing material for so-called ESG funds that were not following any ESG strategies. Although being marketed as ESG funds, the funds owned stocks in companies that were not considered by the industry nor the SEC as ESG friendly. Furthermore, some of the fund managers didn’t even have ESG tracking mechanisms in place, despite running funds that were supposedly investing in ESG stocks.
The point of this article is not to bash ESG stocks or funds but to inform investors that while ESG funds are attempting to do good things, you may be giving up investment returns in return.
As long as you understand the risk of missing out on potential gains and are fine with that, then ESG investing is very admirable, and perhaps it has a great place in your personal portfolio. Trust me; it has a large place in my wife’s portfolio.
Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.