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Curatia Analysis for Tue, Aug 20

ESG (1 of 2): Skepticism

Despite a growing focus on environmental, social and governance (ESG) factors in investing, industry skepticism toward the emergent strategy persists. Critics say ESG investing hampers returns, emphasizes optics over meaningful change, and even lacks a consensus definition.

Today we’ll explore that skepticism in greater detail before pivoting to a survey of projects financial firms are undertaking to build out ESG infrastructure and tap into investor interest in the approach tomorrow.

By the Numbers

US pension funds including $366B behemoth Calpers have begun reconsidering their emphasis on ESG investing principles in recent months as they chase returns in a bid to make up a $4.2T collective funding shortfall.

The trend reflects growing doubts that investors can either earn comparable returns or effect social change through ESG investing strategies. A 2016 academic study found that average annual returns in states with legislated ESG mandates trailed those in other states by 0.4%.

Other institutional investors appear to share those misgivings. 70% of respondents to a Natixis survey of roughly 500 institutional investors cited “improved image and reputation” as a key benefit of ESG investing. Just 18% said ESG investing enhanced returns.

An April poll of large asset managers in the UK meanwhile found that investors’ faith in fund managers to effect social change may be misplaced — at least at present.

While 86% of respondents said they’d called on oil companies to adopt specific goals set out in the 2015 Paris climate accord, only 43% had staked out punitive measures for noncompliance. Further, just 18% set deadlines for meeting the goals discussed. Without such measures, fund managers’ demands are arguably toothless.

Limited Traction?

Investor skepticism is also reflected in slower adoption of ESG investing principles in the opaque world of hedge funds. In a May Preqin survey, just 20% of hedge fund firms already had their own ESG policies in place, compared with 53% of private equity firms.

An industry tilt toward performance-based fees could make hedge funds even more averse to adopting ESG investing principles that could be viewed as constraining. A scant 37% of hedge fund managers said they thought ESG would grow in importance in the next five years.

Against that backdrop, ESG firms are struggling to prove “they’re more than a marketing gimmick.” ESG investing app Swell said in July it was shutting down after it managed to attract a mere $33M in assets in two years of existence.

Even some name brands have stayed out of the fray. Although BlackRock has projected the market for ESG ETFs to grow from $25B today to $400B by 2028, rival Charles Schwab — the US’s fifth-largest ETF provider — has so far refrained from creating an ESG ETF.

Many Meanings

Schwab investors have expressed keen interest in ESG. But the firm believes differing expectations around ESG offerings has led to a proliferation of funds that have failed to achieve critical mass in terms of AUM.

That state of affairs speaks to an ESG Catch .22: Broad-based ESG funds force investors to compromise on what they’re looking for, while niche funds appeal to a narrow audience.

More generally, the many meanings of ESG are captured in extreme variations in the market’s quoted size.

A May 20 Bloomberg piece described the “$23 trillion market for doing good;” a May 30 Bloomberg article cited a JPMorgan report estimating the size of the “active and systematic asset management universe for ESG” at $720B; a June 6 Bloomberg story pegged the size of “green finance” at $31T.

On the whole, skepticism toward ESG investing and disagreement over its scope reflect the space’s immature state. Without ESG reporting standards — the US Congress rejected a move to introduce a European-style framework last month — or a set of industry-standard indices, firms could struggle to introduce performant funds with broad investor appeal.

Tomorrow we’ll examine finance firms’ efforts to develop such infrastructure organically in the absence of ESG regulation.