New Challenges to the Merits of ESG InvestingAdvisor Perspectives
The data used to measure a company’s compliance with environmental, social and governance (ESG) guidelines is inconsistent and leads to misleading results. Moreover, when teams at the same company manage comparable ESG and non-ESG funds, the former more often underperforms the latter.
The popularity of sustainable (ESG) investing has led to increased attention from researchers. Mark Anson, Deborah Spalding, Kristofer Kwait and John Delano contribute to the literature with their study, The Sustainability Conundrum, which was published in the March 2020 issue of The Journal of Portfolio Management.
They began by noting that “sustainability or ESG is a very broad term that is interpreted in many different ways by many different investors.” This leads to problems in definitions and wide dispersions in ratings of the same companies. Their findings led them to conclude that the data regarding sustainability and ESG rankings are inconsistent and hinge on the application and interpretation of different ranking systems using different factors with different weights on those factors – the available ESG data does not provide clear guidance on which companies are delivering superior environmental results.
Next, they devised a closed-loop experiment to identify whether sustainable investing adds or subtracts value. They identified 24 asset managers in which the same fund company, and the same portfolio team, managed two comparable funds –portfolios with and without constraints using sustainable metrics. They stated: “This is as close to a scientific experiment as we can devise to determine whether there is an advantage or disadvantage to sustainable investing.” They added: “The choice of sustainable data source is not an input for our analysis or conclusions. Last, we do not need to worry about the choice of benchmark, because the active manager is competing against itself.”
- More managers earned lower returns when pursuing a sustainable mandate or when applying sustainable metrics: 13 managers with negative returns and 11 managers with positive returns.
- The negative alpha of those managers that generated negative returns was larger than the positive alpha generated by those managers with positive returns.
- The average alpha generated across the full sample of managers was almost -1% and was statistically significant at the 5% confidence level (t-stat of -2.01). (But the sample is small.)
Read the full article here by Larry Swedroe, Advisor Perspectives