Friday, March 25, 2022

ESG Investing Can Do Good or Do Well, but Don’t Expect Both

The claim that investors will make more money investing in green bonds is patently absurd. This is the second in a series of Streetwise columns on sustainable investing.

By James Mackintosh of The WSJ. Excerpts:

"The biggest and boldest claim of ESG investors is that investing based on environmental, social and governance conditions will not just improve our world, but make you more money. I have problems with both parts of the claim. The burgeoning market for green bonds shows the difficulties clearly, and stocks with a sustainability label aren’t so different.

Green bonds, where governments or companies promise to spend at least some of the proceeds on something environmentally friendly, are having their moment. More were sold last year than ever, and this year global issuance is forecast by BNP Paribas to climb another 60% to $900 billion. The U.K.’s first green government issue, last summer, attracted the highest demand ever for a British bond, and the green tinge is rapidly spreading from Europe to the rest of the world.

The claim that investors will make more money investing in green bonds is patently absurd. Green bonds typically have a slightly lower yield than a standard bond from the same issuer. This locks in guaranteed underperformance for taking identical risks that the government or company will fail to pay the bonds back.

Worse, the rapidly expanding sales of sovereign green bonds of developed countries are doing nothing for the environment, and most corporate green bonds achieve nothing either."

"The underperformance of green bonds is easy to demonstrate, and shows up in the “greenium”—the higher price, and so lower yield, for a green bond. In the case of the U.K.’s green gilt, as British government bonds are known, this showed up as a yield about 0.02 percentage points lower than would be expected from a normal gilt with a similar maturity. In Germany, where the comparison is simplified by matching green and traditional bonds, the green bond has a yield 0.05 percentage points lower. Holding these green bonds until maturity guarantees worse performance than those who hold ordinary bonds.

Investors who want to stop global warming might be happy to stump up a little extra to achieve their aims. The U.K. government, like all green-bond issuers, promises to spend the money on green projects, which include renewable energy, clean transportation and flood-control measures. 

Investors shouldn’t bother: The British government, in common with all developed democracies, sets its spending priorities before deciding how to finance them. All these green projects would have happened anyway. In the jargon of green finance, there is no “additionality” from the bonds—and there shouldn’t be. In a democracy, it is voters, not global financiers, who decide government spending priorities."

"This trade-off between trying to do the right thing and making more money is obvious in bonds. But it is fiercely disputed by ESG investors in stocks, even though the same issues apply."

"A company doing everything right on ESG might still be wildly overpriced; an all-male, all-white coal-mining-to-tobacco conglomerate run by Dr. Evil could be so cheap as to be a great—if unpleasant—investment. Even if ESG issues matter as their proponents say, the price is a vital determinant of future returns even over long periods. Simply buying “good” companies isn’t a route to outperformance.

Danish clean-energy company Orsted shows the problem: From its extremely high valuation at the start of last year, stock in the poster-child for the zero-carbon transition has plunged 41%, while coal stocks have soared.

If ranking companies by ESG scores really could help identify companies that will produce higher or more stable earnings, those companies should have a higher price, as everyone wants higher and more stable earnings. But once the better profit outlook is priced in, there’s no further outperformance.

The case for doing well by doing good can at best only be temporary; in spite of the thousands of asset managers running trillions of dollars who have signed ESG pledges, advocates have to believe both that ESG helps earnings, and that it still isn’t priced in."

"trawling through the ESG reports isn’t work for do-gooders, it’s for capitalists. “Clean” stocks will sometimes be overpriced and “dirty” stocks sometimes cheap, even after including ESG information, and to profit you have to be willing to sell the clean stocks and buy the dirty ones—the exact opposite of what ESG investors do.

If ESG truly offers rewards to investors, it brings no virtue. If it is virtuous, expect a lower reward."

Related posts

The hidden costs of corporate social responsibility

Why the Sustainable Investment Craze Is Flawed

C.E.O.s Are Qualified to Make Profits, Not Lead Society

ESG Investing in the Pandemic Shows Power of Luck

ESG Investing Shines in Market Turmoil, With Help From Big Tech: The strength of socially responsible funds suggests they have staying power; ‘ESG is not a fad’

Funds that market themselves as sustainable investments aren’t necessarily focused on companies that fight climate change, develop wind turbines or promote diverse boards

ESG Funds Draw SEC Scrutiny (companies that pursue strategies to address environmental, social or governance challenges)

Is it a retailer’s job to keep shoppers from their vices? (or Adam Smith vs. CVS pharmacy)

Can You Find Virtue by Investing in Vice?

What if companies pledge to adhere to social and environmental accountability guidelines?

Conspicuous Consumption, Conspicuous Virtue, Thorstein Veblen (and Adam Smith, too!) 

Data show that socially responsible investments can outperform the S&P 500 index

Is altruism a result of selfishness?

Do you have to be selfish to make more money?

Does collective self-deception mask selfish behavior?

Why Doing Good Makes It Easier to Be Bad

Businesses intentionally display their social and environmental performance in addition to their financial performance to stakeholders

Should you invest according to religious guidelines?

Companies Adapt to Activism by Athletes 

For a humorous view of this issue see

A Snickers a Day Keeps the Doctor Away: Why does CVS want to make my migraine cures hard to find? by Joseph C. Sternberg of the WSJ


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