Common Objections to Impact Investing

In previous posts, we introduced BDF’s Impact Investing portfolio, a portfolio that tilts towards companies that do better than their peers on attributes such as their environmental impact. We discussed the rising popularity of this style of investment, the rapid rate of adoption by investors, and the money management industry’s quick response to developing solutions. This uptick in popularity has come with some bumps in the road. In 2022, we’ve seen a backlash in some corners of the press against this style of investing. What points are being made, and how are they relevant (or not) to BDF’s portfolio? Here is a breakdown of the most frequent topics:

• Fees for ESG Funds Are Higher Than Non-ESG Funds – Within any class of investment products, there will be a range of fees. However, one should not assume that ESG funds are all more expensive or that a premium must be paid to invest this way. As BDF was researching and vetting the funds that now comprise our ESG portfolio, we were very cognizant of investment fees, which is why the fees of our ESG offering are in line with our typical portfolio.

• ESG Funds Perform Poorly – As discussed previously, we don’t predict sustained outperformance or underperformance from an ESG portfolio. Articles written recently about the performance of ESG funds usually point to very recent underperformance. While near-term underperformance is true, it directly coincides with an incredibly strong run for energy stocks. The energy sector has crushed the S&P 500 this year and all the other sectors within it. ESG funds, which strive for a lower environmental impact, are typically underweight to energy stocks. But if you zoom further out, you’ll see that the energy sector massively underperformed the S&P 500 in 2019 and 2020, and those were good times to have less energy in your portfolio. Investments tend to revert to their mean, so you have to be careful when drawing conclusions about the performance of ESG – or any other investment – over short periods of time.

• The Holdings Are the Same – If you glanced at the top ten holdings of DFA’s US Sustainability Core fund, it would be easy to mistake it for any other large-cap mutual fund. You’ll see Apple, Johnson & Johnson, and JPMorgan amongst the top names. Investors have plenty of niche funds to choose from that target very specific initiatives like renewable energy or women-led companies. The BDF Impact portfolio was intentionally designed to look and behave like our core portfolio, and that means that many of the holdings will look similar to a non-ESG fund. However, the aforementioned DFA Sustainability fund has a 78% reduction in greenhouse gas emissions relative to the fund’s benchmark.

• “ESG Is a Scam” – This is a quote from Elon Musk in response to Tesla being dropped from S&P’s ESG index. An investor interested in shifting drivers away from fossil fuels may applaud Tesla for providing sustainable impact solutions. However, others may take issue with their corporate governance procedures, their environmental practices along their supply chain, or their lack of diversity programs. To be sure, implementation of an ESG solution can be messy, with definitions that leave room for interpretation. But there are things an investor can do to minimize those complications. The fund companies that we work with are not beholden to an index. They can evaluate holdings based on their own research and multiple third-party sources to reach their own conclusions.

We’re pleased to offer an ESG solution to clients who wish to see this reflected in their portfolio. ESG is a rapidly expanding and evolving area of investing, and we believe a thoughtful, deliberate approach can help investors avoid the pitfalls and issues highlighted above.