ESG has become a punching bag for the far right, for disgruntled corporate executives and even industry insiders. But there’s one group whose growing disapproval might be the ultimate game changer.
Retail investors are slowly starting to look under the hood of the $40 trillion environmental, social and governance industry that’s increasingly steering their savings, and many aren’t liking what they see. What’s more, some of the biggest names in finance have been tainted by greenwashing allegations, with Goldman Sachs Asset Management and the investment arm of Deutsche Bank AG among the most prominent.
The cracks in the ESG firmament appear to be widening elsewhere, too. After attracting huge amounts of money for three straight years, demand for ESG is cooling. Flows into ESG funds globally slumped 36% in the first quarter, according to data provided by Morningstar Inc. It's the worst showing since before the pandemic began and was followed by another decline in April, Bank of America analysts reported. In May, investors made the biggest-ever monthly redemptions from US exchange-traded ESG funds, Bloomberg Intelligence estimates.
And ESG returns, which rode out the worst lockdown-induced selloffs, also are starting to sag. By the second week of June, European ESG equity funds had, on average, lost 14%, compared with an 11% decline in the Stoxx Europe 600 index. In the US, they lost 16%, which was only marginally better than the S&P 500.
But perhaps more importantly, doubts about how much good ESG actually does risk becoming a more lasting turn-off for regular people.
When Neil Baker, a 37-year-old who works in the UK construction industry, started looking for ESG investments less than two years ago, he said he was dismayed at what he found. One stock he really didn’t want to own was Facebook parent Meta Platforms Inc. But finding an ESG fund without big tech was almost impossible, he said.
“I don’t want to over-ham it too much, but I felt like I’d almost been had because I thought I was buying into the more ethical side of this,” he said. “And then you start looking, you’re thinking, why is Facebook in there?”
While ESG fund managers may have good reasons for building their portfolios the way they do, the gap between the complex strategies they’re applying and the expectations regular people have of what ESG should do is starting to be a problem that’s playing out in real life. For example, the investment arm of Danske Bank A/S this year adjusted an ESG portfolio amid complaints from consumer advocates about the presence of fossil-fuel stocks. Danske initially pointed out it was playing by the rules, but eventually removed the assets in question.
Financial professionals that deal directly with retail clients are starting to speak out about the disillusionment they’re seeing. For non-institutional investors trying to navigate ESG, “there’s confusion across the board,” said Dan Lane, a senior analyst at UK-based online retail broker Freetrade Ltd.
Industry insiders readily admit that ESG remains hard to define. “What is an ESG fund? I literally have no idea myself,” said Gemma Woodward, head of responsible investment at Quilter Cheviot, which designs bespoke ESG products for professional and retail clients.
Baker ended up ditching ESG altogether and going with a broad index fund. He might be among the few who even bothered to look into ESG in the first place, according to a recent survey by Charles Schwab. It found that 66% of UK retail savers don’t care whether their allocations are sustainable, and instead only want to maximize returns.
If those survey results play out in real life, the ESG industry could be facing an abrupt halt to a party that Bloomberg Intelligence estimates has inflated to roughly a third of the global total for assets under management.
Nor does it help that most ESG funds rely on third-party ratings that are largely unregulated and that have been heavily criticized by financial professionals for lacking consistency and transparency.