The best investment?
ESG investing is now mainstream – but measuring the performance of ‘green’ products and their asset managers is complex
We are currently seeing a huge growth in demand from investors for products reflecting environmental, social and governance (ESG) concerns, such that this trend can no longer be dismissed as a fad.
Earlier this year, financial analysis and research group MSCI put a figure of $20 trillion on the total of ESG investment products in portfolios – about a quarter of all funds under management, according to McKinsey & Co. This proportion seems likely to grow further as more asset managers offer ESG products to their investors.
But as ESG-related investing has moved from niche activity to the mainstream, the question arises how to measure the performance of the managers in question. After all, while ESG investing is about ‘doing good’, as with all investment, it is also about getting a return.
The way in which we measure ESG investment performance can have a significant effect on the direction that such investment takes. More on that in a moment.
First, what sort of comparisons would it be useful to make? Simply setting an ESG manager’s performance against another index, such as Standard & Poor’s 500 index (arguably the most influential benchmark in the world) would be both unhelpful and unfair. The S&P 500 contains a number of so-called ‘sin’ stocks, representing corporate interests in industries such as tobacco and others that would not feature in many ESG portfolios.
These sin stocks have an average annual return 2.5% higher than that of their ‘ethical’ fellows, as evidenced here.
So, the S&P 500 and similar indices, such as London’s FTSE 100 index, are not an appropriate yardstick by which to judge an ESG manager’s performance. For this reason, a number of specifically ESG-related benchmarks are coming into play, such as those offered by MSCI and FTSE Russell.
In time, these indices will become increasingly important, in line with the expected continued expansion in ESG investing. This, as we shall see, will make it evermore pertinent to know how these benchmarks are constructed in terms of what is included and what is not. One might think it’s a relatively simple business of excluding, for example, stocks in fossil fuel-based firms and packing the benchmark with shares in wind turbine manufacturers. The reality is rather more complex.
