Sustainable investing has been booming this year. Analysts noticed a major surge of investment into mutual funds and EFTs that center around socially responsible investing.
That means a boom for ESG funds, which saw inflows of $577 billion in capital from January to September of this year. For comparison, these funds saw inflows of just $355 billion over the whole of 2020.
Even before the steep rise in 2021, the industry reported strong gains. Collectively, investors held some $17.1 trillion in assets chosen according to ESG criteria at the start of 2020. Just two years earlier, that figure was just $12 trillion.
ESG Investing—what is it
Over the past few years, investors have increasingly chosen to put their money in projects that align with their values. This usually means that investors will prefer to invest in companies that are ecologically sustainable and socially responsible.
That is why brokerage companies have started offering exchange-traded funds (ETFs) that follow ESG criteria. The term comes from the acronym for environmental, social and (corporate) governance. If a company passes these criteria, it is listed in the ESG fund.
ESG projects can focus on the environment, alternative energy, more sustainable communications or transportation solutions. These include hydrogen, solar and wind power generation, as well as investment in modern rail infrastructure.
How is ESG different from other types of investing
In essence, ESG investing is no different from any other type of financial project or investment fund. The difference is in the tradeoff between profits and positive social impact.
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In theory, the focus on sustainability can create long-term benefits on companies—and their investors. There are many companies positioned to profit from a gradual shift towards sustainability.
Investors might also benefit financially from their social consciousness. As public opinion shifts, government regulations are likely to benefit companies that fit ESG criteria.
Moreover, some ESG projects feature disruptive technologies that have huge potential upsides. For example, hydrogen tech could revolutionize the transportation industry. Early investors could get a head start in earning solid income.
However, in practice, projects that fit ESG criteria usually have lower rates of returns. This is particularly true for ESG municipal and government bonds.
But that does not mean that ESG projects are not worthwhile. ESG investors care more about having a positive impact on the world than just bringing in high returns.
Opportunities in ESG investing
The benefits from ESG investment are potentially great in terms of their positive impact. Because some investors are prepared to support sustainable projects, companies are incentivized to shift their business models.
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If a company fits ESG criteria, it could have cheaper access to capital. In turn, the company could fund its more sustainable initiatives. Access to capital could also help it compete with other, less sustainable businesses. This could, in time, completely transform how companies do business.
Hopefully, the transformation would be for the better. However, there are also some potential risks.
Not everything is as it seems
The unprecedented ESG boom is—at least in part—a result of the huge government stimulus policies, which can create an incentive for projects to pose as ESG.
Unfortunately, there are many projects that are completely unrelated to what ESG is supposed to be. These projects, oftentimes, use the cover of ESG to get the investment they need. “Greenwashing,” or presenting a fake ESG narrative, has become a serious issue in the industry. So much so that some investors are calling the space a trick.
Moreover, one hedge fund manager even said that there’s an opportunity in exposing “fake” ESGs. Hedge funds could short, and expose companies that don’t live up to their claims over sustainability, this way bringing more attention to the situation in ESG investment landscape.
Projects that just pose as ESG could crowd out investments from better initiatives that may have a lower rate of returns. The key issue is in finding the right criteria for what qualifies as an ESG project.
The case of Tesla
The difficulty is even greater when companies do well on some ESG segments, but not on others. Tesla is a notable example. Despite the company’s focus on fixing climate change, it has a remarkably low ESG rating.
For example, JUST Capital, an ESG research non-profit, puts Tesla at the bottom 10% of all companies. Yet, it is difficult to argue that Tesla only attracts shareholders that just care about the profits.
Many of Tesla’s shareholders believe that the company is doing a lot to tackle climate change. For some, that is precisely the reason they are investing. Still, a segment of Tesla’s investors are pushing the company towards improving its ESG rating on all segments.
For that reason, ESG could evolve to offer a more diversified set of criteria that could fit the values of a diverse set of investors.
Future of ESG
Despite the risks involved, ESG funds do seem to have a bright future ahead of them. The demand for sustainable investing is certainly there.
It’s up to financial innovators to solve the issues that the space faces. This may include hedge fund watchdogs ready to call out bad players and a more diversified set of funds with criteria to reflect the values of a diverse set of investors.
