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In an article for AdvisorPerspectives, Larry Swedroe of Buckingham Wealth Partners discussed the conundrum of ESG investing. In essence, the asset class is currently outperforming which many are interpreting as a validation of ESG’s promise. 

Yet, Swedroe contends that this conclusion is incorrect, since it doesn’t include the effect of increased inflows. In fact, a recent study from Norway’s oil fund revealed that non-ESG stocks actually delivered superior returns over a longer time period. One potential explanation is that inflows lead to increased valuations for ESG stocks, while it leads to depressed valuations for non-ESG stocks. 

Another explanation for the conundrum is that ESG stocks are less risky, because they on balance tend to have higher compliance standards and risk-management protocols. In the long-term, stocks with higher risk profiles tend to have better returns albeit with increased volatility. 

Companies with higher ESG scores also tend to be larger than companies with lower scores. This is another complicating factor as smaller companies tend to deliver higher returns over the long-term due to the risk premium. 

Overall, investors should understand that ESG outperformance is likely to be a short-term phenomenon due to the surge of inflows. Over the longer-term, the asset class could see lower returns due to a lower risk premium.

Finsum: ESG investing is booming, and many believe the asset class will continue to outperform. Larry Swedroe explains why it’s not so simple.

In March, investors withdrew a total of $5.7 billion from US-listed ESG ETFs, leaving ESG funds with total assets of $81 billion according to reporting from Barron’s Lauren Foster. 

A major factor in the outflows was Blackrock rebalancing its passive holdings which resulted in a $3.9 billion outflow in a single day. Other factors that accounted for this were cited as political backlash, increased regulatory scrutiny, poor performance, and market volatility. 

In Europe, ESG flows are also depressed relative to 2021 but remain positive. In the US, it’s become a political issue as many conservatives are criticizing corporations for involvement in political affairs. Recently, President Biden vetoed legislation that would prevent pension funds from considering ESG factors in their investments.

There has also been some movement at the state level where conservative leaders are pursuing actions such as divesting from financial institutions that don’t invest in energy companies or companies engaging in political activity. So far, these efforst have failed but show that the tide could be turning against ESG.

Finsum: ESG funds saw major outflows in March due to a variety of factors. However, it’s clear that ESG is increasingly becoming a political issue. 

Over the last two months, there has been a 15% increase in the asset base of biodiversity funds according to an article by Natasha White of Bloomberg. This is a relatively new segment of the ESG market which saw a 150% increase in the number of funds last year. 

Overall, biodiversity is a fraction of the overall ESG market with combined assets of $2.9 billion. To compare, the overall ESG market is estimated to have $41 trillion in assets. The largest biodiversity funds are from Northern Trust, Axa Investment Managers, and Lombard Odier. All three are based in Europe, where there is a more defined regulatory environment. 

One catalyst for the asset class was the agreement at the COP15 summit in December of last year, where the Global Biodiversity Framework was signed by nearly 200 nations, with the intent to mobilize $200 billion annually to preserve and maintain biodiversity.

A challenge for the nascent fund class is the lack of standardized data on biodiversity which means there is disagreement on best practices and assessing impact. A larger issue is that many experts believe that the tradeoff between earning financial returns and maximizing biodiversity is too steep and thus can only be attained through public policy.

Finsum: Biodiversity funds have seen a 15% increase in assets over the last two months and a sharp boom in formation over the last couple of years. While there is agreement on the importance of preserving biodiversity, there are doubts whether it can be attained while generating positive returns for investors.

Investors have been expressing a growing interest in addressing ESG issues with the filing of a record number of shareholder resolutions to be considered this proxy season. According to As You Sow, the Sustainable Investment Institute and Proxy Impact in the Proxy Preview 2023 report, investors filed 542 shareholder resolutions concerning ESG issues in 2022 that they want public companies to take into consideration. The organization said that the leading concerns were climate change, corporate political influence, racial justice, and reproductive and worker rights. Many of these will be voted on at spring and summer corporate annual general meetings. While politicians are arguing over the merits of ESG investing, “Investors have shown long-term support for companies adopting for net-zero greenhouse gas goals and reporting on the management of climate risks and opportunities,” according to Michael Passoff, CEO of Proxy Impact and co-author of Proxy Preview 2023. He also added that “Shareholder resolutions have always been at the forefront of these efforts — first by educating companies and investors about climate risk and solutions, and more recently by calling for quantitative metrics on greenhouse gas emissions reduction targets, alignment with science-based targets, and incorporating climate-risk mitigation into executive compensation packages and company-wide business strategies.”

Finsum:Investors continue to show a growing interest in addressing ESG issues with the filing of a record 542 shareholder resolutions concerning ESG issues in 2022 that they want public companies to take into consideration.

According to a report released this month by the Investment Company Institute, only 2.5% of defined contribution plan participants stopped contributing to their plans last year. This suggests that despite market volatility, Americans are still exhibiting disciplined savings habits. The report, titled “Defined Contribution Plan Participants’ Activities, 2022,” examined participant-directed changes in DC plans by tracking activity through recordkeeper surveys and comparing it to data going back to 2008. Based on the results, DC plan participants remained committed to making contributions like they had in previous years. For instance, only 2.2% of participants stopped contributing in 2021, 2.3% in 2020, 2.3% in 2019, and 3.4% in 2009. In fact, the withdrawal activity of defined contribution plan participants was 4.1% in 2022, the same as in 2021. In prior years, the percentage of plan participants who took withdrawals was 3.8% in 2020, 3.9% in 2019, and 3.1% in 2009. While levels of hardship withdrawal activity increased slightly last year, they were still low in absolute terms. This indicated that despite a challenging market environment, Americans are set on protecting their retirement savings, which was the conclusion of the ICI report.

Finsum:According to the results of a recent ICI report, only 2.5% of defined contribution plan participants stopped contributing to their plans last year despite a challenging market environment.