“Some believe,” Deloitte said in the report, “that we are entering the watershed moment where the growth of professionally managed assets with an environmental, social and governance (ESG) mandate will only accelerate until it encompasses the vast majority of all professionally managed assets.”
Any movement with this kind of momentum deserves a strong dose of skepticism. However, managers in the space take issue with critics who argue ESG is just a marketing gimmick employed by frustrated active managers.
“There’s an optic around ESG that it is mainly a marketing approach,” says Mike Hunstad, head of quantitative strategies at Northern Trust Asset Management. The reality, in his view, is that “100% of this is client-driven. With European and Australian clients, they demand it. It’s basically table stakes.”
Looking across the asset management landscape, Hunstad says many rivals are struggling to keep up. “Investor demand is driving this,” he says.
The stampede into ESG is spawning a smorgasbord of businesses looking to service the burgeoning industry. At least five ratings agencies are now offering a variety of metrics to help asset managers analyze companies on the characteristics that dovetail with their strategies.
Already there are critics. At a recent press luncheon in April, Loomis Sayles portfolio manager Dave Rolley voiced a question about ESG ratings. Until early March, a leading provider of these ratings, MSCI, assigned a “BBB” rating to Russia and a “CCC” rating to General Motors, despite the auto giant’s hugely ambitious plan to transform itself into a leading producer of environmentally friendly electronic vehicles.
Rolley also wryly noted that last time he checked, General Motors CEO Mary Barra “hadn’t invaded three countries.” A quick scan of other ESG ratings could also produce similar dubious evaluations.
Other ESG raters and money managers have made themselves targets for critics many times before. In 2010, numerous ESG and other socially conscious funds were holding shares of BP, which had promoted itself as a next-generation energy concern even as its Deepwater Horizon well leaked millions of barrels of oil into the Gulf of Mexico.
Yet the performance of MSCI stock is another powerful indicator of how lucrative the ESG and overall indexing business is. Between May 1, 2017, and April 13 of this year, MSCI shares climbed from $102 a share to $493.
There is a flip side to the herd mentality building around the popular concept. When too much money chases too few stocks, the resulting imbalances can create value. It shouldn’t be a surprise that value stocks, including those from old industrial smokestack America, are staging a comeback.
In the five quarters since January 1, 2021, energy has been the best-performing of 11 industry groups within the S&P 500. After the oil and gas industry faced a near-death experience following the fracking bust of 2015, Wall Street has demanded capital discipline from these companies, which have been shunned as dogs by most investors and treated as toxic by many politicians.
As Envestnet’s D’Auria noted in an article in Financial Advisor’s September 2021 issue, ESG has yet to be tested over a full market cycle. That’s one reason Northern Trust’s Hunstad has merged his firm’s ESG strategy with a quality, or profitability, component, that has been tested “to outperform over 30 to 50 years.”
In the meantime, as ESG strategies continue to evolve, disputes and intrinsic contradictions are likely to proliferate in ways Friedman and the original Earth Day activists could not have imagined. “It is our fiduciary duty to control ESG [factors], even if you don’t care about morality in investing,” Hunstad says.