ESG funds are getting slammed from all sides these days. For much of the last year, conservative politicians have blamed them for a host of problems ranging from high gas prices to virtue signaling with other people’s money.

After several years of stellar performance, thanks partially to heavy technology weightings, many funds in the environmental, social and governance category began struggling in 2022. In March 2023, it was reported that MSCI would downgrade the number of “AAA”-rated mutual funds and ETFs in the category from 1,100 to 54.

Late last year, a Harvard study found that 68% of the holdings in many mutual funds marketed with ESG standards were exactly the same as those in other broad-based funds outside the category. ESG investors were paying an average of 20 basis points more per year for investments that weren’t all that different, the researchers concluded.

The report added fuel to a debate that’s been raging for decades. Is socially responsible investing (sometimes called “sustainable investing”) an overpriced marketing gimmick?

‘Investors Have Been Misled’
“You can own the cheapest S&P 500 ETF and get nearly the same return as the ESG funds for a fraction of the fees,” says Mark Neuman, CIO and founder of Atlanta-based Constrained Capital, which was not connected with the Harvard study. “Investors certainly have been misled into thinking they are getting a specialized ESG fund when in fact they’re just getting basic S&P exposure.”

Vanguard recently made headlines in January when it withdrew from a climate change alliance of asset management complexes. But Vanguard has seven ESG funds in the space, and they brought in nearly $2 billion in new money in 2022, Morningstar said, making Vanguard the nation’s No. 1 ESG fund manager.

These vehicles can look a lot like their non-ESG counterparts. Apple, Microsoft Corp. and are the top three holdings of both Vanguard’s ESG U.S. Stock ETF and its non-ESG Total Stock Market ETF.

Granted, these three companies—all of which have been considered good corporate citizens at one time or another for their fair hiring practices and other policies—amount to 15.5% of the ESG portfolio and only about 12.4% of its non-ESG counterpart. But the ESG fund’s expense ratio is 0.09%, while the non-ESG fund’s is only 0.03%.

Investors Want ESG
To some ESG investors, though, the extra cost, particularly a paltry 6 basis points, doesn’t matter. They’re glad to find ESG options available from reputable vendors. “We recognize that interest in sustainable investing is increasing for some investors,” says Laura Cope, a Vanguard spokesperson, “and [we] aim to provide ESG investment choices that meet their preferences.”

That interest is rising is indisputable. In 2021, total ESG investments in the U.S. grew 55%, as measured by Morningstar, with more than $500 billion flowing into ESG mutual funds alone (as opposed to individual companies that are considered ESG-friendly). Last year, when U.S. mutual funds had a net outflow of more than $370 billion, the nation’s ESG funds still brought in roughly $3 billion in new money.

Last October, PricewaterhouseCoopers projected that total ESG investments in the U.S. would grow from $4.5 trillion in 2021 to $10.5 trillion in 2026. Globally, the PwC report concluded, “ESG-orientated funds are set to grow much faster than the market as a whole.”

In another study, Capital Group found that 89% of investors consider ESG issues a part of their investment approach.

Investors of many stripes agree good governance is desirable, and they have long sought to influence corporate policies in ways that align with their personal values—either by putting money into companies that have proved themselves to be good corporate citizens or by withholding it from those that aren’t.

Over the years, niche funds have emerged that adhere to specific religious values or that pursue particular social justice issues such as diversity, equity and inclusion (DEI) or environmental priorities. Meanwhile, the advent of direct indexing has allowed managers to customize portfolios to meet the preferences of individual investors.

Even some ESG skeptics see potential here. “There is no universal measure of goodness,” says Constrained Capital’s Neuman. “Everyone’s opinions of the most important ESG characteristics are personal. Therefore, investors must choose their investments based on their own views.”

Sustainability Is The Future
Joe Keefe is the president of Impax Asset Management, a Portsmouth, N.H., asset manager specializing in environmentally focused equities. Keefe says there’s already a transition underway for a more sustainable economy in the decades ahead, and his firm builds portfolios “best positioned to benefit from this transition and away from sectors, industries and companies that we believe are likely to fall behind.”

This is part of his firm’s fiduciary duty, he says, because these investments have the best promise for the future, and ESG investing makes sense in the economy as it is today. It’s not at all about feeling virtuous. “Our primary focus is on delivering above-market returns,” he says.

“ESG issues or factors are increasingly considered by most asset managers for the simple reason that they are increasingly deemed as material to how companies perform, and therefore to how investment portfolios invested in those companies perform,” he says.

Not ‘Woke’ Capitalism
That, in part, is why political attempts to rein in ESG investing make Keefe angry. “Some politicians of late have been rallying against ‘woke’ capitalism, whatever that means,” he says. “I frankly don’t think limiting choices available to investors is a market-based approach at all.”

He’s not alone in being outraged at political interference. In early March 2023, both houses of Congress voted to reinstate restrictions on the use of ESG considerations in retirement and pension plans. The US SIF, a nonprofit research organization in Washington, D.C., that advocates for socially responsible investing, swiftly urged President Biden to veto the measure (which he subsequently did), saying in a press release that it would interfere with plan sponsors’ fiduciary duty “to focus on relevant risk-return factors and not subordinate the interests of participants and beneficiaries.”

Kiley Miller, principal director of sustainable investing at Envestnet PMC, a popular investment platform for advisors, agrees. ESG investing, she says, incorporates relevant but hard-to-quantify factors related to corporate culture, corporate reputation and brand value. These are “dimensions that increasingly drive valuations,” she says. “We cannot ignore this information and continue to fulfill our fiduciary duty.”

True ESG Costs Money
If environmental, social and governance funds appear to mimic the S&P 500, Miller says, it’s simply “because of the rapid adoption of ESG-aware ETFs that were specifically designed to have relatively low tracking error to a standard market index.” Those who are willing to pay more, she explains, can get different exposure through actively managed ESG funds.

“When it comes to ESG, you get what you pay for,” says Rachel Robasciotti, CEO and founder of Adasina Social Capital in San Francisco, which prides itself on being not only Black-owned but mostly operated by women, people of color, and members of the LGBTQ+ community. For ESG portfolios to truly make an impact on society, Robasciotti says investment managers must spend money on grassroots research, gain community input and gather non-financial data before translating that information into practical terms.

Robasciotti goes a step farther. True socially responsible investing, she says, cannot come from traditional investment structures. They are too far removed from the problems and issues people are facing.

“We should all be looking first to the communities we intend to help, and the social justice organizations leading the work within those communities, for the best answers about how to help,” she says. “When companies tell investors that they can make a substantial impact with their investment in a cheap ESG product, that investor is probably being misled.”

Mixing Charity With Investing
If you don’t want to spend more for an actively managed ESG fund, Constrained Capital’s Neuman suggests investing for maximum returns and then “use those profits or proceeds to get involved with your favorite ESG causes.”

Steven Schacter at Forest Hills Financial Group in Chappaqua, N.Y., might concur. “ESG funds are smoke and mirrors, just different packaging and more gift wrapping than ordinary funds,” he says. “I counsel my clients not to mix politics and investing. If you strongly believe in a cause, donate a tax-deductible contribution.”

Yet some see no better way of engaging in causes than putting your money where your mouth is. “The old Wall Street canard that you should just make as much money as you can and then give it to the cause of your choice ignores the world-shaping role of corporations and capital allocation today,” says Mark Regier, vice president of stewardship investing at Praxis Mutual Funds in Goshen, Ind. “What businesses do and how they behave affect all of us and the future of the planet itself. No amount of charitable giving—or even government action—can eclipse this level influence.”

Making Tough Choices
To be sure, if investors want to be better corporate citizens, they may have to make some tough choices. “It’s important to do your due diligence or work with an advisor who has done that,” says Matt Dmytryszyn, CIO at Telemus Capital in Chicago.

Investors must make sure an ESG fund is employing the values they want, he says, and in the way they want. So if, say, DEI is important to them, they could invest either in corporations with diverse boards or companies that are taking efforts to become more diverse.

“Both are reasonable approaches,” he says.

But it’s unavoidable that investors will become frustrated with some companies’ behavior. Amazon, a mainstay of many ESG funds, has lately come under fire for fighting unionization and mistreating employees. “But just because ESG isn’t perfect doesn’t mean you have to scrap the whole movement,” says Patrick Dinan, founder of Impact Fiduciary in Glendale, Calif.

It takes time and effort to screen properly for companies that match an investor’s values, says Michael Finke, professor of wealth management at the American College of Financial Services in King of Prussia, Pa.

But if you believe in a cause, he says, why not put values ahead of profits? “After all, many investors are in a position of abundance that allows them to achieve charitable goals while they’re alive by supporting businesses they believe in,” says Finke.