Advisers still think ESG strategies underperform

Despite mounting evidence to the contrary, performance worries still keep advisers from implementing investment strategies that take into account environmental, social and governance concerns.

A study released Monday by Cerulli Associates found that while more than 50% of advisors have either used an ESG product in the past 12 months or will use an ESG product in the next 12 months, 35% of those who don’t use ESG investments cite concerns about lowering client performance. The Cerulli survey also affirms InvestmentNews research showing that just 19% of advisers who use ESG cite performance as a reason for doing so.

The notion that embracing ESG means reducing returns stems from outmoded ideas about ESG, said Max Mintz, a financial adviser with Common Interests.

“The old idea of ESG was where managers excluded entire sectors of the economy,” Mr. Mintz said. “In today’s world, ESG can be additive to performance, but many advisers have not lifted the hood on new products.”

Newer ESG approaches score companies by environmental, social and governance concerns, and invest in those with the best scores, even if they are part of a sector that ESG funds have traditionally avoided, such as energy and chemicals.

Several recent studies have shown that ESG can, in fact, boost performance over the long term, primarily because of companies with high governance scores. Companies that score poorly on governance often have a higher cost of capital, and struggles with labor and fraud, according to MSCI.

A study by AQR, for example, noted that “ESG may have a role in investment portfolios that extends beyond ethical considerations, particularly for investors interested in tilting toward safer stocks. ESG exposures may inform investors about the riskiness of the securities in a way that is complementary to what is captured by traditional statistical risk models.”

Jeremy Grantham, chief investment officer for the GMO funds, presented research at the Morningstar conference earlier this month showing that eliminating some sectors entirely isn’t particularly harmful over the long term. Mr. Grantham found that removing energy from the Standard & Poor’s 500 stock index for the past 30 years increased performance very modestly, by .03% annually.

Neverthless, the Cerulli report notes that the dominant problem that asset managers have with ESG investing is limited or selective disclosure on ESG issues, with 34% of those surveyed citing it as a significant challenge and 60% saying it was somewhat of a challenge.

The second most problematic feature of ESG investing was the subjective nature of ESG factors: Not everyone agrees that defense stocks are socially unacceptable, for example.