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ESG vs. Smart Investing

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(Ca-ssis/Getty Images) Even if it didn’t underperform, ESG investing would be a moral mess.

Environmental, Social, and Governance (ESG) are the three hottest words in the investment industry today. How hot? Bloomberg says “ESG assets may hit $53 trillion by 2025, a third of global AUM (assets under management).”

The conceit of ESG is simple. Mix environmental hygiene, social justice, and virtuous governance; shake; and pour. Behold, the perfect portfolio. Feel good while getting rich. Finally, one can align his values with his investments. A good and honorable IRA.

You might recognize ESG as a marketing refresh of SRI — Socially Responsible Investing, which gained limited popularity in the 1990s. Same idea, new name.

So, how does ESG perform as an investment?

The simplest measure, the S&P 500 versus Large Cap Blend funds (the category for the S&P 500), shows that 60 percent of the time the average Large Cap Blend fund beat the average Morningstar High Sustainability rating (a measure of ESG) fund of the same type in the last ten years (2011-2020). On average, ESG was a loser.

Morningstar Inc. says its own ESG indexes outperformed in 2020. Others — NYU finance professor Aswath Damodaran in a recent piece called “Sounding good or Doing good? A Skeptical Look at ESG,” and the Journal of Business Finance & Accounting — say ESG failed during the COVID-19 crash, and if you correct for tech tilt (under the hood, ESG is simply a tech play), its returns dissolve. Overall, a report from Pacific Research Institute concludes, “ESG funds have not yet shown the ability to match the returns from simply investing in a broad-based index fund.”

However, for argument’s sake, let’s say that investment returns are neutral — that ESG performs as well as non-ESG. Under the assumption that returns won’t be affected, why not choose ESG? What is wrong, in principle, with ESG?

The answer is the same one that every Christian gets in his college dorm room when practicing apologetics on his roommate. Ultimately the dispute narrows down to values;

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