ESG funds are a potential source of conflicts of interest for investors
As I’ve often mentioned, the biggest risk you face as an investor is hidden or unrecognized conflicts of interest. It’s not because any one conflict of interest can do great damage to your finances. The risk comes out of the fact that conflicts of interest are everywhere.
That’s especially so with ESG (Environmental, Social and Governance) issues. These issues may come with pure motives, but they require outlays that depend on judgment calls rather than financial analysis. Companies deal with these issues by hiring outside consultants and firms to help with decisions. These outsiders supply guidance on how companies should spend their money. The advice they give can raise or lower a company’s profits. This is a potential source of conflicts of interest, for the companies and the consultants.
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In July 2022, when the ESG craze was at its peak, The Wall Street Journal ran an article entitled “The many reasons ESG is a loser.”
The article went on to analyze a number of mutual funds that were pursuing an ESG-focused investment mandate. It turned out that funds trading under the ESG banner were, on average, charging higher fees and reporting worse results than comparable funds that stuck to the old-fashioned profit-seeking motive.
The article also quoted University of Colorado Prof. Sanjai Bhagat, writing in the Harvard Business Review, who made four important points about ESG:
“1) ESG funds have underperformed;
2) Companies that tout their ESG credentials have worse compliance records for labor and environmental rules;
3) ESG scores of companies that signed the UN Principles of Investment didn’t improve after they signed, and financial returns were lower for those that signed; and my favorite point;
4) Companies publicly embrace ESG as a cover for poor business performance. It makes sense. When earnings are bad, companies cite their focus on ESG. When earnings are good, they drop ESG references. Actually, this is dangerous as ESG metrics drive overinvestment by ESG funds in companies bragging about their credentials right as their financials turn south. Ouch.”
No matter how you feel about ESG and similar concepts, it pays to remember an investment rule we’ve mentioned many times over the years: A successful investor’s most valuable tool is a healthy sense of skepticism. It’s also good to keep that rule in mind at this time of year, when you shop for holiday gifts.
Many ads and corporate greeting cards tell customers about the charitable causes they’ve donated to, in hopes that this will lead you to buy whatever they’re selling. This is not necessarily the best value you can get for your money.
It can be inspiring when a profit-seeking business supports a worthwhile cause. But you still should comparison-shop so you get good value for your money. After all, when a company names the charities it is supporting, but doesn’t reveal the size of the donation, it may amount to pennies per sale.
If you shop wisely and donate your savings to the cause directly, the charity will receive more money from you to devote to the cause, and you’ll be able to write off your donation as a tax deduction.
We suggest avoiding ESG funds
We’ll stick with our long-time view: if you want to make money and do good with your investments, invest in so-called “plain-vanilla” investments. Then, if you wish, as mentioned, you can donate part of your profits to a cause you support, and get a tax deduction.
Bonus tip: Use our three-part Successful Investor approach for all of your investments:
Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
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