The Dirty Secret of Environment, Social, and Governance (ESG) Investing

In 1987, the movie Wall Street gave us an all-time financial villain. His name was Gordon Gekko. His mantra: “Greed is good.”

Gekko is a warning to investors. He challenges us to reach for something higher than greed.

That’s where ESG investing comes in…

You’re probably aware of “ESG.” It stands for “Environment, Social, and Governance.” It’s a benchmark for the ethics of a company or investment.

A company that fights pollution might rate well in “E.” Community-minded businesses do well in “S.” And a highly accountable board might earn high marks in “G.” These are simple examples, but you get the idea.

The easiest way to own ESG stocks is by buying an exchange-traded fund (“ETF”). An ETF holds a basket of stocks sharing a single theme… So an ESG ETF would hold companies committed to social responsibility.

At the end of 2021, ESG-oriented funds held $357 billion in assets. They’re projected to make up one-third of assets under management by 2025.

What started as an ethical ideal has turned into big business. And immediately, the financial industry set out to do what it does best… give it the Gordon Gekko treatment.

Today, I’ll show how it’s happening right now in ESG funds… and how you can avoid it.

An identity crisis has come to ESG.

Take energy stocks. In ESG, small carbon footprints are the order of the day. And Canadian oil leaves a higher carbon footprint than Russian oil does…

So at the end of 2021, ESG funds held twice as much Russian oil as Canadian oil. Oops.

As Russia’s invasion of Ukraine has since shown, a lower carbon footprint doesn’t necessarily mean social responsibility. Companies and countries have been pulling out of Russia for just that reason.

Defense stocks tell a similar story today. Weapons of war were once full-on ESG taboos… But then, unprovoked war broke out in Ukraine. Last month, a leading Swedish financial group with ESG commitments allowed six of its funds to invest in defense stocks as a result.

The meaning of “social responsibility” changes with the times. That makes ESG a moving goalpost… which is never a great financial strategy.

The problems run even deeper than that, though…

Like most ETFs, ESG funds usually track pre-built indexes. The fund managers bring institutional know-how to your portfolio and charge you for their services. But you pay slightly more for the “ethical” touch.

In 2020, ESG funds charged about 0.61% in fees, while their conventional peers charged 0.41%. That’s not a crazy premium. And it might seem worth it for the benefits of ESG investing. But there’s a problem…

Let’s zoom in on one of these funds – the iShares ESG Aware MSCI USA Fund (ESGU) – to see it.

ESGU is one of the largest ESG ETFs in America, with more than $25 billion in assets under management. And it only charges 0.15% in fees. That’s well below the industry average.

The charts below compare ESGU to another leading ESG ETF. We’ll call this one “Fund X” for now. Check it out…

The charts look identical, right?

Well, I lied before: Fund X isn’t an ESG fund. It’s the iShares Core S&P 500 Fund (IVV).

This is a broad-based ETF that tracks the S&P 500 Index. It charges a fee of only 0.03%. That’s 80% less than ESGU and 95% less than the industry average.

And here we have the dirtiest secret of ESG investing… Most “ESG” funds are S&P 500 funds in expensive wrappers.

ESG investors are buying a wholly unremarkable product. The two funds above share eight of their top 10 holdings. And the weightings are mostly the same. No wonder their performance is near-identical.

As much as socially responsible investing is worth striving for… this is the nature of the industry. Financial companies make products that sound exciting. But they often turn out to be pricier versions of the old, boring standbys.

Wall Street has put the Gordon Gekko spin on ESG funds. And until it changes, you’re wise to avoid these high-fee, back-door index funds.

Good investing,

— Sean Michael Cummings

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Source: Daily Wealth