Do you know that feeling when you find out something you’ve been doing is actually not as helpful or beneficial for the world as you thought? That’s how many investors feel about ESG funds right now.
And no, these don’t have anything against eco-friendly funds per se. The idea that there are companies out there thinking of ways to make the world a better place while also making money investing in them—that’s awesome. While the benefits of ESG ETFs investing are clear, there are drawbacks too – and they’re not what you might expect.
This article explains why this is the case for ESG ETFs and what investors should look out for before committing their hard-earned cash to ESG ETFs.
What Is an ESG ETF fund?
When an investment fund claims to be sustainable, responsible, or ethical, the fund managers will try to invest in companies they believe are ethically responsible. This can include avoiding investments in things like tobacco and other harmful industries, being mindful of environmental impact, and considering employees’ working conditions.
While the idea of sustainable, responsible and/or ethical funds sounds like a great way to invest ethically, it’s worth being aware that there are some drawbacks. Here are some of them:
Not as Eco-friendly as They Seem
The truth is that ESG ETFs may not be as eco-friendly as you think. This is because fund managers are human, and humans are fallible. They may not always make the right call when it comes to choosing which companies to invest in. After all, fund managers have a fiduciary duty to their investors, and they may be tempted to invest in companies they think will offer the best returns.
Unfortunately, if the fund manager focuses more on making money than being eco-friendly, the fund could end up becoming anything but ethical. Let’s say that a fund manager is mindful of environmental impact when determining which companies to invest in. But they notice that one of their investments is engaged in fracking and has been fined for pollution.
Should the fund manager divest from this company? Or should they stay put? The decision is debatable, but it’s a decision fund managers must make.
The Performance Issue
ESG funds are controlled by fund managers who make all the investment decisions, which means they’re responsible for any losses. However, whereas most investors will look at a fund’s past performance to see how it’s done, sustainable funds don’t provide much information. This is because it’s difficult to determine what caused the fund to gain or lose.
If a fund manager has been focused on doing good, they may have caught a lucky break that had nothing to do with their investment decisions. Alternatively, if the fund has lost money, it may have been due to poor investment decisions. It’s hard to tell, which makes it hard to evaluate a sustainable fund’s performance.
This is particularly true for investors who are new to sustainable, responsible, and ethical funds. They may be tempted to choose a fund that has performed well in the past. However, because sustainable funds are actively managed, past performance doesn’t indicate future results.
Environmental, Social and Governance Risks
Another risk associated with ESG ETFs is that they’re invested in more than one company. If a company goes bankrupt, it could take a sizable chunk of a sustainable fund down with it.
On the other side of the coin, if a company is sold, a sustainable fund may end up with a new owner who doesn’t share the same values. This means that the fund managers may have to divest from the company. Of course, this can have a negative impact on the fund’s performance.
Some Companies Practice Greenwashing
Finally, it’s important to remember that companies can sometimes trick you into believing they’re engaged in sustainable, responsible and/or ethical practices. This is what’s known as greenwashing.
To avoid falling for a company that greenwashes its practices, it’s important to check their credentials, online reviews, and even approach them to find out for yourself. If you’re unsure whether a company is being honest, you can ask them for information. If they don’t respond, you have your answer.
Summing It Up
ESG funds have become an area of growing interest among investors. The belief that these principles can offer a competitive advantage is one reason for this trend. Another is the belief that ESG funds can produce better risk-adjusted returns over the long term.
Eco-friendly investments sound like they should be good for the environment, but they’re not always as green as you might think. And because of this misconception, eco-friendly investments may not always be the right choice for your needs.
Make sure you do diligent research before making a decision.
