Is ESG worth it?
Analysts at Barclays grappled with that question in a recent report titled "ESG funds: Looking beyond the label," a look at whether investing in assets based on environmental, social and governance factors actually leads to better financial outcomes.
In the report, the firm wrote that growth in ESG "has been driven by interest in sustainable investing rather than superior performance," citing data that showed "ESG funds have delivered roughly similar returns to other equity funds since 2013."
Another point of contention for Barclays was that ESG-labeled products don't necessarily give investors more exposure to ESG metrics, with analysts calling for more transparency and standardization in ESG scoring.
Assets across all types of ESG funds climbed above $1 trillion last quarter as buyers piled into the space, a growing collection of investment products focused on various themes including clean energy, minority empowerment and social responsibility.
ESG ETFs in particular have pulled in over $35 billion of net inflows so far this year. The iShares MSCI USA ESG Select ETF (SUSA), the Vanguard ESG U.S. Stock ETF (ESGV) and the iShares ESG Aware MSCI USA ETF (ESGU) are all beating the market this year, up roughly 16%, 15% and 14% respectively. All three hit all-time highs in Wednesday's trading.
That outperformance largely speaks for itself, Mona Naqvi, head of ESG product strategy for North America at S&P Dow Jones Indices, told CNBC's "ETF Edge" on Monday.
But "just as with any investment decision, investors are responsible for doing their due diligence and making sure that they really look at the specific fund or index objective," she said.
On one side of the ESG spectrum are funds that get high marks for sustainability, but end up seeing a "significant deviation from the market and a differentiated return," Naqvi said. On the other side are "core replacement" strategies that look a lot like S&P 500-based funds with slightly more exaggerated exposures to their ESG-friendly components, she said.
"Some of those core replacement beta-like approaches are designed to offer only modest, albeit meaningful, improvements in ESG, so, you're not necessarily going to see a substantial differentiation," Naqvi said, pointing to the Xtrackers S&P 500 ESG ETF (SNPE) as one example.
"At the same time, that's what allows these products to be so accessible to the broader market, because you're getting that pretty much identical benchmark-like exposure," she said. "That's really about reducing those barriers to entry and getting investors comfortable with departing from standard indices and standard investment products."
As for Barclays' concerns around standardization, Naqvi acknowledged the challenge of making apples-to-apples comparisons when different issuers tend to focus on different scoring metrics including, in some cases, qualitative data.
"Qualitative information can be really useful because you're not going to get that from the regulatory filings," Naqvi said. "These are the things that are really driving corporations' value today, whether it's brand, reputation, good will. That's really what ESG is trying to capture. Inherent in that [are] some subjective value judgments, but that's what I think adds so much value and intrigue to investors in this market. It's possible that these assets are mispriced. Everybody has a different opinion and that's what creates such a significant opportunity."
However, mispricings could lead to obstacles for ESG funds. The U.S. Department of Labor proposed a new rule in June that could curtail ESG's influence in retirement accounts such as corporate pensions and 401(k) plans by reminding plan providers that it's unlawful to sacrifice returns for certain social or political gains.
"It does seem to be in the opposite direction of where the rest of the world is heading in terms of regulation," Naqvi said. "But ... I think that the question isn't so much 'Does ESG investing necessarily lead to outperformance?' which I think is an assumption in the proposed rule, but instead, 'Does it inherently imply underperformance?'"
For Naqvi, that answer is an "unequivocal no," evidenced both by ESG's outperformance in recent years and the emergence of products like SNPE "where there is no trade-off," she said.
"We're really kind of dispelling that myth of an inherent ESG-versus-performance trade-off by offering these core replacement strategies, and I don't really think the rule really has any place to apply to those types of strategies when, really, you're getting very similar risk and return to the benchmark," Naqvi said.