There is a significant increase in the number of commentators taking a swing at ESG investing and suggesting that it is neither effective nor in the best interest of investors as it likely puts them at risk of underperformance. The performance piece has largely been a moot point until now as the funds flowing into the ESG space have been high enough to ensure outperformance from a simple supply/demand perspective, see chart below. However, should the flow of funds slow and investments be judged on their own merits many fund managers are going to find that they own some egregiously expensive stocks with fundamentals that do not support the valuation. If this then leads to a rotation out of a sub-set of names, the future outperformance of the class is far from guaranteed.
On the ability of ESG investing to impact corporate behavior, the doubters point to the simple divestment of stocks as what most unhappy ESG investors do to show their displeasure. This has limited impact on any company as their stocks are bought and sold every day. Declining equity multiples will eventually have an incremental effect on the cost of capital, but this alone is unlikely to have a major impact on corporate behavior. Where we have seen an impact has been on shareholder votes, but these have been largely focused on governance issues, often targeting a board restructuring or executive pay. As yet we have not seen major shareholder resolutions targeting some of the less tangible social issues or climate. Whether or not ESG investing can be an effective agent of change will depend on whether fund managers are willing to step up to the fight as these resolutions appear, especially if they are backed by litigation, or whether they will divest away and hide from the possible conflict. See more in today's daily report.