Do sustainable funds perform better?
By asset class, sustainable equity funds posted the strongest gains, showing a 10.9% median return and outperforming traditional equity funds' 8%. Fixed-income outperformance was more muted, with sustainable funds at a 3.8% median return vs. traditional funds' 2.2% (see Figure 1).
Sustainable Funds Outperform Across Asset Classes
growth equities, or short vs. long duration fixed income. By asset class, sustainable equity funds performed best, with median returns of 16.7% for the full year, outpacing the 14.4% realized by traditional equity funds.
The research shows that it is not necessary to underperform when investing for sustainability. Whether one is investing in individual stocks, indices, or funds, an investor can achieve market performance or better.
Funds that invest using environmental, social, and governance, or ESG, criteria underperformed for a second consecutive year.
Some studies suggest that companies with high ESG scores tend to outperform the market, while others indicate no significant difference. The relationship between ESG factors and stock performance may vary based on the time horizon, sector, and region.
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.
There is a potential for “greenwashing”
Some companies may make claims about their ESG practices that are not fully supported by their actions which can lead to “greenwashing”. This may make it difficult for you as an investor to identify truly sustainable companies.
Activist investors are expected to carry out fewer environmental and social campaigns this year after the strategy proved less lucrative than other shareholder agendas, according to business consulting firm Alvarez & Marsal Inc.
The short answer is no. Academic evidence (see for example the meta-studies by Friede et al. [2015] and Atz et al. [2022]) shows that sustainable investing typically does not cost financial returns.
- iShares ESG Screened S&P 500 ETF (XVV)
- Invesco Solar ETF (TAN)
- iShares Global Clean Energy ETF (ICLN)
- Democracy International Fund (DMCY)
- Nia Impact Solutions Fund (NIAGX)
- VanEck HIP Sustainable Muni ETF (SMI)
- Matthews Emerging Markets Sustainable Future Fund (MASGX)
Why have sustainable funds fallen?
According to Morningstar, this was driven by “persistent macroeconomic pressures and waning investor appetite for ESG and sustainable products”. The firm also pointed out that active sustainable funds suffered the strongest outflows in Europe in Q4 while passive funds maintained “positive momentum”.
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.
Additionally, some critics have raised concerns about the complexity and reliability of ESG metrics. But much of the backlash is driven by the perception that ESG criteria are biased against certain industries like oil and gas. Critics argue fund managers are prioritizing political goals over generating returns.
A study from The Journal of Finance found that out of a pool of 20,000 mutual funds with $8 trillion in assets, those rated highly for ESG factors did not outperform those rated poorly. There are many possible reasons for this.
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing.
ESG funds have had about the same amount of risk as their peers. When it comes to the risk of an investment portfolio like a mutual fund, one common measure is the standard deviation of returns.
Some opponents also believe that ESG investing is politically motivated and could lead to biased investment decisions.” In a line used by proponents, those in opposition to the ESG movement also believe there is substantial support behind them.
Prominent Republican politicians, such as Florida Gov. Ron DeSantis, have assailed ESG as "woke" capitalism that prioritizes liberal goals over investor returns, harming U.S. companies deemed insufficiently progressive and in turn hindering the wider economy.
BlackRock is still wagering that fighting climate change will be a generational investment opportunity—but the company is no longer pushing for changes in corporate behavior, talking about hard-to-quantify social issues or actively promoting ESG investing criteria.
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.
Are ESG funds less risky?
Investing in ESG funds also carries lower risks. This is because in a world which is painfully waking up to the far-reaching consequences of climate change, where consideration of ESG aspects will become indispensable for the conduct of businesses.
In the short run, a surge in demand for sustainable companies can drive up their stock prices. However, this phenomenon is transient, and in the long run, the higher prices could result in lower stock returns as investors settle for diminished returns on their investments.
We expect growth in ESG investing to continue through 2022, and well beyond. The shift to sustainable investing is so powerful because it's being driven by demand from the bottom up.
While there is some evidence that companies with high ESG ratings perform better financially, it is also possible that these companies are simply better managed overall and would perform well even without ESG initiatives.
An overwhelming majority of CEOs—92%—say they plan to continue their ESG (environmental, social, and governance) initiatives despite the public backlash, according to a survey of 260 CEOs and investors conducted by CEO consulting firm Teneo.
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