Warning: Because there is a paucity of alt-energy stocks that don't rely on cobalt mined by children in the DRC (for example), certainly not $30 trillion worth, the vast majority of equities touted as ESG by the marketeers are tech stocks.
In part this is because the Google's of the world can claim energy efficiency by talking revenue per kilowatt of electricity used or carbon neutrality because their data centers use hydro-produced electricity or because they don't have smokestacks that some ambush photojournalist can snap pictures of or, whatever.
What this means in practical terms is that when you buy ESG you are buying growth and hypergrowth stocks. Meaning that if there actually is a rotation to value/small cap/other factors etc,. ESG is going to lag, possibly dramatically and ESG investors had better be resigned to underperformance for a long time, and possibly until behaviors are mandated by force of law..
This isn't where the below piece is going but is something that should be top-of-mind any time the subject comes up.
From K@W:
If money talks, then investors could surely prod corporations to espouse environmental, social and governance or ESG aspects in how they run their businesses. “Sustainable investing produces positive social impact by making firms greener and by shifting real investment toward green firms,” according to a recent paper titled “Sustainable Investing in Equilibrium,” by finance professors Lubos Pastor at the University of Chicago, and Robert F. Stambaugh and Luke Taylor at Wharton.
In order to achieve those gains, investors are happy to sacrifice on returns. “In equilibrium, green assets have low expected returns because investors enjoy holding them and because green assets hedge climate risk,” the paper stated.
However, they do outperform the rest of the market when there are unexpected shifts in customers’ tastes for green products and investors’ tastes for green holdings, the authors added. The paper provides theoretical guidance for investors and researchers to help them interpret data on ESG investing, said Taylor.
ESG investing totaled $30.7 trillion at the start of 2018 across the five major markets of the U.S., Canada, Europe, Japan and Australia/New Zealand, according to the latest report from the Global Sustainable Investing Alliance. That figure represented a 34% increase over the prior two years in ESG investing.
The ESG Factor
The first key finding of the study is that green assets have higher prices today and therefore they should have lower expected returns in the future. Therefore, green assets should be “bad” investments, since they should underperform, on average.
However, the returns of green assets also depend on what the researchers called the “ESG factor.” The ESG factor could cause green assets to perform well for two reasons. “It could be that consumers become more interested in buying the products and services of green companies, or it could be that investors become more interested in holding green assets. If those changes come as surprises, then green assets can outperform,” said Taylor.
“[ESG investing] increases the amount of green activities in the economy and it reduces the amount of brown activities in the economy.” –Luke Taylor
“If the ESG factor performed well during a 10-year period, then during that 10-year period, you could see green assets outperforming brown assets,” or stocks of companies that do not specifically embrace ESG criteria, Taylor explained. In other words, although the researchers predict that green assets will underperform, “sometimes green assets will get lucky and outperform,” he added.
The luck factor refers to “random events” – events that were unpredictable, said Taylor. For instance, customers may unexpectedly start buying more products of green firms, or it could be that investors unexpectedly care more about green investments. This finding is based on the study’s model and not on an empirical study of returns from stock prices, he clarified.
The study’s observations resonated with the findings of a 2009 paper by Harrison Hong and Marcin Kacperczyk that investors pay a financial cost in abstaining from so-called ‘sin stocks,’ which they define as alcohol, tobacco and gaming stocks. “They show that the sin stocks outperform the non-sin stocks,” said Taylor. “That supports our prediction that green assets, on average, underperform brown assets.”
Another key finding of the paper by Taylor and his co-authors is that ESG investing changes the way that companies behave. “ESG investing has positive social impact,” said Taylor. “That means it increases the amount of green activities in the economy and it reduces the amount of brown activities in the economy.”
ESG investing achieves that in two ways. First, ESG investing reduces the cost of capital for green firms, making it easier for green firms to raise capital and thereby leading them to expand their operations, Taylor said. “So, you would see more expansion in green operations and for the same reason you would see a reduction in the operations of brown firms.”
For example, ESG investing would lead to more wind farms, more solar farms and fewer coal mines, he continued. The second way ESG investing works is by inducing all companies to become greener, because doing so increases their market values. For example, because of ESG investing, a company will choose to install pollution-reducing scrubbers at a coal burning plant, he explained.
“We think this is good news for society and also for ESG investors,” Taylor said. “When people follow these ESG investing strategies, they have a positive benefit on the world. It’s not just about changing stock prices.”....
....MUCH MORE
