Are we working on building a better world, a better society for the future? Are businesses focusing more on positive impacts rather than profit? Are capitalists directing more investments into businesses that promote and ensure sustainability? Are investors widely supporting ESG (Environmental, Social, and Governance) goals? And, are they making money from doing so?
A March 31 article in the Harvard Business Review titled “An Inconvenient Truth About ESG Investing” notes that, “Investing in sustainable funds that prioritize ESG goals is supposed to help improve the environmental and social sustainability of business practices. Unfortunately, close analysis suggests that it’s not only not making much difference to companies’ actual ESG performance, it may actually be directing capital into poor business performers.”
Author Sanjai Bhagat, Provost Professor of Finance at the University of Colorado, and author of Financial Crisis, Corporate Governance, and Bank Capital, published by Cambridge University Press, wrote, “to begin with, ESG funds certainly perform poorly in financial terms… That result might be expected, and it is possible that investors would be happy to sacrifice financial returns in exchange for better ESG performance. Unfortunately, ESG funds don’t seem to deliver better ESG performance either.
“As of December 2021, assets under management at global exchange-traded ‘sustainable’ funds that publicly set environmental, social, and governance (ESG) investment objectives amounted to more than $2.7 trillion; 81% were in European based funds, and 13% in US based funds. In the fourth quarter of 2021 alone, $143 billion in new capital flowed into these ESG funds. How have investors fared? Not that well, it seems,” Bhagat wrote.
Bhagat cited a recent Journal of Finance paper detailing the analysis by University of Chicago researchers of the “Morningstar sustainability ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings.” He noted that while “the highest rated funds in terms of sustainability certainly attracted more capital than the lowest rated funds, none of the high sustainability funds outperformed any of the lowest rated funds.”
He also cited research work by Columbia University and London School of Economics that looked into the “ESG record of US companies in 147 ESG fund portfolios and that of US companies in 2,428 non-ESG portfolios.” Bhagat noted that “companies in the ESG portfolios had worse compliance record for both labor and environmental rules. They also found that companies added to ESG portfolios did not subsequently improve compliance with labor or environmental regulations.”
He added, “A recent European Corporate Governance Institute paper compared the ESG scores of companies invested in by 684 US institutional investors that signed the United Nation’s Principles of Responsible Investment (PRI) and 6,481 institutional investors that did not sign the PRI during 2013–2017. They did not detect any improvement in the ESG scores of companies held by PRI signatory funds subsequent to their signing. Furthermore, the financial returns were lower and the risk higher for the PRI signatories.”
While Bhagat’s assertion is backed by studies, these were mainly concentrated on US investors and US companies. In this line, his article does not necessarily reflect the ESG picture worldwide. However, the study results are enough to make one ponder whether “ESG investing” is actually delivering positive results, particularly in wealthier nations. Is capital truly moving away from so-called “dirty” industries?
It will be interesting to see a similar analysis on ESG investing covering Philippine companies and investors. One wonders what such analysis can reveal about business and investor sentiment on ESG investing and how invested funds have fared in the last five years. Also, is the focus on ESG making investing less profitable? Or, as Bhagat asked, “Why are ESG funds doing so badly?”
“Part of the explanation may simply be that an express focus on ESG is redundant: in competitive labor markets and product markets, corporate managers trying to maximize long-term shareholder value should of their own accord pay attention to employee, customer, community, and environmental interests. On this basis, setting ESG targets may actually distort decision making,” he wrote.
“There’s also some evidence that companies publicly embrace ESG as a cover for poor business performance,” he said. “Funds investing in companies that publicly embrace ESG sacrifice financial returns without gaining much, if anything, in terms of actually furthering ESG interests.”
Bhagat cited a recent paper by Ryan Flugum of the University of Northern Iowa and Matthew Souther of the University of South Carolina that noted, “when managers underperformed the earnings expectations (set by analysts following their company), they often publicly talked about their focus on ESG. But when they exceeded earnings expectations, they made few, if any, public statements related to ESG. Hence, sustainable fund managers who direct their investments to companies publicly embracing ESG principles may be over-investing in financially underperforming companies.”
This leaves one with the bad impression, correctly or otherwise, that companies’ commitment to ESG goals is just lip service. Pretty much like NATO, I guess, which is defined by some as “No Action, Talk Only.” And while Philippine law requires particularly listed companies to report on their ESG commitments and initiatives, I am uncertain whether such a requirement actually matter to the investing public. Moreover, do such regulations actually encourage ESG investments?
Locally, there seems to be confidence that ESG investing works. Paul Chester See, Assurance Partner at PwC Philippines, noted, “Initially, the ESG factors were only used by investors to determine potential investments. Nowadays, ESG gains more recognition among investors because it raises public awareness on the environmental and social influence of companies. Investors want to know that a company is creating long-term value. They are looking for businesses that have sustainable paths and a sustainable strategy that considers these factors. In fact, sustainability itself will become a license to operate for most businesses.”
In an article posted on the PwC Philippines website, he added that investors and business owners perceived “ESG as a form of social responsibility — a broader obligation to society as they reinforce a more sustainable future for the world. Environmental, social, and governance concerns may seem new to local business but this year  proves that we need to embrace it now more than ever. ESG will continue to be essential even in the post-pandemic world as it amplifies a company’s resiliency to unforeseen global or local crises.”
Despite the US experience, however, perhaps there is hope yet for ESG investing in the Philippines. As BusinessWorld reported previously, local investor interest in ESG actually grew even during the pandemic. For one, BDO Unibank, Inc.’s sustainability themed unit investment trust fund (UITF) saw its assets under management (AUM) grow to almost P100 million by end-2020, from P75.2 million in 2019, and just about P55.5 million when the fund started in 2016.
“While the fund is still small, it has the potential to grow in size and importance as more investors are consciously looking for companies that protect the environment, are socially responsible, and practice good governance in a sustainable manner,” BDO said of the growth. The UITF’s returns were at 13.95% and 19.9% in the second half and the fourth quarter of 2020, respectively.
Of course, a P100-million fund like this is just a drop in the bucket for BDO. But it will be interesting to see how other locally managed ESG-connected investment funds have been faring since 2021. Are they just as successful? Also, are local investors willing to receive lower profits in favor of building a better world? And, will the incoming administration continue in the next six years the policy and regulatory push favoring the growth of local ESG investing?
Marvin Tort is a former managing editor of BusinessWorld, and a former chairman of the Philippine Press Council