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Continuing our blog series about ESG investing, in this article we’ll address some of the misconceptions surrounding this field today. As explained in our previous blog post, ESG refers to the three main factors used in measuring the sustainability and ethical impact of investing in a company, and the acronym stands for ‘Environmental’, ‘Social’ and ‘Governance’.

Before we examine the myths, we want to stress that how to invest in ESG is just as important as whether to invest. Just as a hammer can be used to build a house or to tear one down, a carefully constructed ESG portfolio can capture financial returns without increasing risk, while a casually constructed ESG portfolio can do serious damage to one’s wealth. With that in mind, let’s dive into some of the main myths of ESG investing:

Myth 1: ESG Investors Sacrifice Financial Performance

While this myth was true in the past, it is now possible to create ESG portfolios that score well on ethical and sustainable investing, but without sacrificing financial goals. However, this is not automatic, as there are large differences between the many ESG funds in the marketplace. Consequently, it is important to perform thorough due diligence on ESG funds to ensure their expected financial performance and sustainable impact are up to par.

Myth 2: ESG Investing Will Provide Superior Risk and/or Returns

The second myth is the flip side of myth #1. While we would be very happy if ESG investing provided some sort of excess return, that is unfortunately not the case. The markets are very efficient in incorporating new information into stock prices, whether that information is about consumer demand for Apple’s new iPhone, the quality of a company’s management, or the environmental risks taken by various oil companies. Because ESG risks are reflected in stock prices, we have constructed ESG portfolios that score better on sustainability factors, but still capture market returns through a strong focus on diversification.

Myth #3: Data on ESG is inadequate and unreliable

The data on ESG has improved considerably the past few years, and reputable data providers such as MSCI, SASB and Sustainalytics are now providing standardized, quality data on thousands of different companies. More and more companies are reporting on more and more metrics, and we have reached an inflection point where there is more pressure on companies to report to these data providers. For example, the MSCI ESG Research team alone consists of 325 employees, including 185 people dedicated solely to researching and analyzing ESG metrics. MSCI is one of several providers of ESG data that has a valuable brand to protect, and that helps ensure improved quality and reliability of ESG data.

Myth #4: ESG investing is a niche field

While ESG investing was a niche field back in the 1990s and 2000s, it is fast becoming part of mainstream investing. The chart below illustrates the strong growth in ESG investing in the United States. A good decade ago, there were 260 U.S. funds with about $200 billion invested under an ESG mandate, while there are now more than 1,000 funds with a total of $2.6 trillion (with a ‘T’) invested based on ESG criteria. That figure represents about 1 in every 6 dollars invested in US funds, and both the number of ESG funds, total ESG assets, and ESG investing as a percent of total investing continue to grow.

Source: World Resources Institute, US SIF Foundation; The data includes funds that incorporate various ESG criteria and is restricted to mutual funds, variable annuity funds, alternative investment funds, exchange-traded funds, closed-end funds, and other pooled products. It excludes community investing institutions and assets not associated with a dedicated fund or manager. Separate accounts were excluded beginning in 2014 to maintain exclusive focus on commingled products.

Source: World Resources Institute, US SIF Foundation; The data includes funds that incorporate various ESG criteria and is restricted to mutual funds, variable annuity funds, alternative investment funds, exchange-traded funds, closed-end funds, and other pooled products. It excludes community investing institutions and assets not associated with a dedicated fund or manager. Separate accounts were excluded beginning in 2014 to maintain exclusive focus on commingled products.

An evolving field

These four are only some of the myths about ESG investing that we have come across during our research into the field. And, in fairness, some of them were accurate as recently as a few years ago. As the ESG field continues to evolve there will doubtless be more current “truths” evolving into inaccurate myths. As always, Private Ocean’s Investment Committee continue to monitor the ESG space in search of better ways to implement ESG portfolios for our clients.