There are costs to living a virtuous life; It requires going without. This is true psychologically, because sacrifice gives virtue meaning. But it's also true mathematically. You pay a price when you constrain who you will buy from, who you will work for, and what you will invest in. When times are good, the costs of a virtuous life may not seem too high, but eventually the bill comes due.

That reckoning is now. We may be seeing the end of the virtue economy bubble. And that's not necessarily bad, because the virtue economy wasn't making the world a better place. It may have even been making it worse.

The idea of letting your values guide your financial life has been growing over the last decade, and really took off during the pandemic. The amount of money in Environmental, Social, Governance (ESG) funds was expected to reach $41 trillion this year.

According to a recent survey from Charles Schwab, 73% of surveyed participants claimed personal values have become a bigger factor in how they make life decisions in the last two years; 82% say their values impact their investing; 76% said when they make a purchase “the values of the company who made the product are an important consideration”, and an astonishing 59% of respondents say they’d take a lower salary to work at a company that shared their values.

But how much those same people are truly willing to pay for satisfying their values is unclear. When it came to investing, a company’s performance was rated first among considerations in the survey; so did price when it came to shopping. Virtue may have been ranking so high in recent years because there wasn't a big cost to virtuous economic decisions—stocks were rising and inflation was almost nonexistent. Times have changed.

Five years ago, hedge funder Cliff Asness caused a small stir in the ESG investment community when he pointed out an obvious truth. He argued that ESG investment funds will typically return less than funds that are free to invest anywhere. He explained that constrained optimization will result in lower returns than unconstrained. It makes intuitive sense: if you need to turn down a good investment because it isn't ESG compliant, that means you’ll earn less money than someone who is free to invest in it. The more constraints you put on yourself, the less you can expect to earn. Asness was baffled that ESG was being sold as a good investment.

For a while, as ESG funds gained popularity among retail and institutional investors, it looked like their returns were higher than funds full of sin. Since 2010, a US ESG index fund (SXEIMUV) has outperformed the S&P 500.

But the true test of any asset class is how it performs in all markets. Once the market began to turn down this year, the S&P fund did better, or less bad, than ESG funds. An S&P fund is down 17.3% from the start of the year, while the ESG index is down 18.7%. A bull market covers many sins—or virtues. Now that the market is turning, even ESG industry insiders are voicing skepticism.

The same is true for where you choose to work or what you buy. You sell your labor, and if you limit the pool of buyers to firms that share your politics that means fewer offers and possibly turning down more money.  When the labor market is tight and you have many employers to choose from, odds are you don’t have to sacrifice much to make this choice. It may be one reason why firms were quick to take political stands on issues that may align with their workers’ values.

Workers may not be able to be so fussy if the labor market softens. Shared values may wear thin if you've got lousy managers or the job doesn’t pay so well. In a higher-inflation environment, taking a pay cut isn't so easy.

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