Does ESG Investing belong in my portfolio?

What is ESG investing?

ESG stands for Environmental, Social, Governance, and refers to the three key factors used when measuring a business or company's sustainability and ethical impact. ESG investors want to invest in companies that are good environmental stewards, that embrace diversity and equality of opportunity, that act ethically and legally, and that demonstrate appropriate corporate governance.

By and large, most financially successful companies today, particularly in democratic societies, already aim to treat all their constituencies fairly. Businesses are more likely to reward their shareholders when also providing benefits to other stakeholders—i.e., employees, customers, suppliers, and the communities in which they operate. We acknowledge that there are exceptions and that opinions may differ on the nature and degree of benefit. But if you think of it, what are the odds that a company will be financially rewarding for its shareholders over the long-term if it treats its customers or employees poorly? Not surprisingly, most investors shy away from companies that do not make all their stakeholders better off.

Investing in ESG Companies: Too Good to be True?

The frequently advertised claim that ESG investments provide a better rate of return is to be treated cautiously. Not only are the periods reviewed often too short to be statistically relevant, but the studies don't always adjust for other factors. For instance, the growth stocks that have outperformed for the past 5 to 10 years (so-called FAANG stocks) dominate many ESG funds' holdings.

Another concern is that many ESG funds apply a screening approach to judging companies using checklists of various ESG factors to produce a grade. A company either passes or fails. These screens are mechanical and absolute, while the reality is more nuanced: for instance, electric vehicles' stocks are a current favorite of ESG funds, and no one disagrees that their widening adoption will have a substantial positive impact on lowering CO2 emissions in the future. Yet, building a battery requires mining large quantities of rare metals at a huge environmental cost in many countries with poor human rights records.

In other words, beware of Wall Street’s "greenwashing" or marketing hoopla.

Finally, does investing in ESG funds have the intended positive impact?  

Focusing on the "E" in ESG, does it benefit the environment to own Microsoft's shares? If investors want to make a difference in saving the planet from climate change, should they disinvest and increase capital costs for today's worst polluters? Or should they provide them with cheap capital—and strings attached—so that they can reduce their impact on the climate and the environment by increasing their green capital spending?

Two industries that have a major negative impact on the environment today are mining and cement. A clean energy transition to wind and solar will require increasing amounts of rare metals and new concrete buildings over the next 20 years. Providing these industries with the financial resources to innovate and dramatically reduce their environmental impact may have a more favorable result than investing in Microsoft shares. This is the thinking behind Climate Action 100+, a global investor-engagement group.

“Be the change that you wish to see in the world.” - Mahatma Gandhi.  

We agree that in the next few decades, the global economy needs to lower its carbon footprint and continue improving social and governance standards. This will be disruptive and provide both investment opportunities and risks. While simplistic checklists won't necessarily help, being successful as an investor will require an awareness of ESG considerations.

Although we personally and professionally welcome our clients' embrace of ESG factors and perspective on any potential investment, we feel that the most widely available options to small investors today are flawed. Our view is that we, as individuals, are more likely to have a significant positive impact on these issues, including on our planet’s environment, by being ESG-conscious consumers (reducing our plastic usage, driving electric vehicles, etc.), supporting ESG policies as voters, and donating to environmental and social justice charities, rather than by investing in ESG funds.

One of Bristlecone Value Partners’ principles is to communicate frequently, openly and honestly. We believe that our clients benefit from understanding our investment philosophy and process. Our views and opinions regarding investment prospects are "forward looking statements," which may or may not be accurate over the long term. While we believe we have a reasonable basis for our appraisals, and we have confidence in our opinions, actual results may differ materially from those we anticipate. Information provided in this blog should not be considered as a recommendation to purchase or sell any particular security. You can identify forward looking statements by words like "believe," "expect," "anticipate," or similar expressions when discussing particular portfolio holdings. We cannot assure future results and achievements. You should not place undue reliance on forward looking statements, which speak only as of the date of the blog entry. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Our comments are intended to reflect trading activity in a mature, unrestricted portfolio and might not be representative of actual activity in all portfolios. Portfolio holdings are subject to change without notice. Current and future performance may be lower or higher than the performance quoted in this blog.

References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and returns do not reflect the deduction of advisory fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase.

Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there can be no assurance that a portfolio will match or outperform any particular index or benchmark. Past Performance is not indicative of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client's investment portfolio.