ESG investing not simple

Environmental, social and governance (ESG) investing is attractive for ethically-minded investors, but investors need to do due diligence, according wealth and superannuation manager Nucleus Wealth.

Damien Klassen, Nucleus Wealth chief executive, said there are two main drivers for investors looking for ESG investments.

“First is the logical reason that an increasing number of people worldwide don’t want to financially support companies whose activities they may disagree with, or at least do not actively support,” Klassen said.

“For instance, gambling, weapons manufacturing, cigarette and tobacco production and distribution, petroleum, coal mining and so on.

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“Second, is that there is a body of research promoted by various ethically investing organisations, such as the Responsible Investing Association of Australia (RIAA), that purport to show that investment returns are greater for ethically operating companies, that is, with a positive ESG rating.”

However, ESG was no “magic pudding” and although it was possible for those funds to perform better, investors needed to do due diligence.

“There are 1,600 stocks in the MSCI World Index – a common investing benchmark containing only very large companies,” Klassen said.

“If you give fund manager A the ability to invest in any stock and fund manager B the ability only to invest in 800 of the better ethical stocks, then you are asking fund manager B to beat fund manager A with one hand tied behind his back.”

This meant that performance was dependent on the screening process, as some screened companies had underperformed but not all had.

“For example, over the past few years, the oil price fell from $100+ to less than $20 and stock prices of oil companies plummeted,” Klassen said.

“Energy is generally negative in ethical screens and so managers who couldn’t invest in oil stocks outperformed those who could.

“In the other direction, there are funds that exclude only tobacco, and these funds over the past 10 years have generally underperformed the world index as tobacco stocks rocketed up.”