At age 25, Kevin Guardia has already been investing for nearly half his life. Guardia’s father opened a small brokerage account for his son when Kevin was in junior high, and the young man started to dabble in buying and selling stocks just as the long rebound from the financial crisis got underway.
Now that he’s on his own, Guardia tackles investing more purposefully. “The whole point of buying a stock is the discounted value of future earnings,” he said. “So you want earnings that are going to go up, but you also want earnings that will be good for the future of this world.”
Guardia’s views on what is “good for the future” are eclectic, just like the diverse drivers luring more investors to embrace the “environmental, social and governance,” or ESG, investing category, a segment of the market also sometimes called sustainable, socially responsible or values investing.
Guardia is concerned about pollution and the environment but is also keenly aware of privacy issues. Kevin’s father supports this approach, but “we have different priorities,” with the senior Guardia’s eyes firmly on returns, Kevin told MarketWatch. The question of priorities has long complicated how ESG investing is viewed, with detractors warning that the full potential for profits is almost always sacrificed to do good and proponents saying that’s nothing but a myth.
Investing professionals have long expected the Guardia family dynamic to unfold across financial markets as a younger generation comes of investing age. Millennials and Generation Z may get blamed for “killing” plenty of old traditions, but they’re also seen as having a lot more heart — and awareness — about how their dollars impact the world. And in the immediate aftermath of two financial market shocks — one from the collapse in oil prices /zigman2/quotes/209723049/delayed CL00 +0.36% and the other from the economic devastation wrought by the COVID-19 pandemic — it’s an impulse that takes on additional weight.
“We have a lot of evidence that this next generation that’s going to take over the world does care,” said Dave Nadig, chief investment officer and director of research at ETF Database. “They’re asking harder questions. The question now is, what is the right way for them to express those opinions?”
Strong inflows back up pledges
That’s a high-stakes, nearly $21 billion question in fact — the amount of new money pulled into funds identified as “sustainable” in 2019. The figure, tracked by Morningstar, marked a nearly fourfold increase over the previous calendar-year record, set in 2018.
In early 2020, even as COVID-19 ravaged mainstream investments , global demand for ESG proved resilient. In the first quarter of 2020, Morningstar found that the global sustainable-fund universe collected inflows of $45.6 billion, compared with outflows of $384.7 billion for the overall fund universe.
For many ESG investing advocates, the flow data is validation. Americans aren’t just claiming to be interested in sustainable investing; they are putting their money where their mouth is. Forward-looking sentiment surveys are also encouraging for those who support this investing theme.
In its 2020 global exchange-traded-funds investor survey, taken ahead of the full force of the pandemic, Brown Brothers Harriman found that an estimated 74% of global investors plan to increase their ESG exchange-traded-fund allocation over the next year . Almost one in five investors said they would allocate between 21% and 50% of their portfolios to ESG funds in five years. BBH, in its report, concluded that ESG “doesn’t appear to be a passing fad.”
Yet even with the inflows and the optimism, ESG remains a landscape fraught with challenges for all ages, from do-it-yourselfers like Kevin Guardia all the way up the investing food chain to someone like Larry Fink, head of $7 trillion asset manager BlackRock /zigman2/quotes/207946232/composite BLK -0.45% . Fink in January announced his firm’s climate-conscious shift and a prediction that climate change will shape all investing in decades to come.
Off the top, ESG labeling qualifications remain fuzzy; fund-manager intent isn’t always clear; and just how returns might be pumped up, for instance with funds retaining some companies with questionable social responsibility in the mix, eludes even the most open-minded investors.
Delivering as advertised?
Values are just as personal in investing as in, say, religion or education. Guardia tries to invest in companies seen as supporting the Hong Kong protesters rather than the Chinese government. Another investor may prioritize investing in companies with diverse boards of directors incorporating more women and people of color on the belief that they will guide that company’s actions in the future, even if its current performance causes other investors to shy away.
There’s a solid chance that if you’ve put some of your own money in a fund marketed as sustainable, you might be surprised and disappointed at the way those ideas are interpreted by the fund manager. That manager may in turn think she has a great “values” idea, but is hamstrung by archaic or inflexible industry customs. There’s plenty of professional piling-on — by financial advisers, wealth-management-product designers and the media, for starters — who don’t really care what “sustainable” technically means, so long as it brings more eyeballs, more dollars and, ultimately, some of the pie for them.
SEC Commissioner Hester Peirce said late last year as the regulator began a review of the sector’s socially responsible promises that “the first issue is that we don’t even know what ESG means,” adding that “defining that would be an important first step before trying to develop metrics.”
This dynamic was on stark display at an exchange-traded-fund gathering earlier this year. One fund-industry pro suggested the X-Trackers S&P 500 ESG fund /zigman2/quotes/213019972/composite SNPE -1.88% should be considered “ETF of the year.” Another scoffed because prominently displayed among the fund’s top 20 holdings is Exxon Mobil /zigman2/quotes/204455864/composite XOM -0.06% , one of the world’s biggest fossil-fuel concerns, he noted.
Indeed, less than half of the funds — 91 of the 303 sustainable funds tracked by Morningstar — are fossil-fuel-free or even “low carbon” by prospectus. As for thermal-coal exposure, 47 funds have none, and another 26 have less than 1% exposure, but 34 sustainable funds have thermal-coal exposure of between 3% and 5% of assets (thermal coal takes up around 4% of broader global indexes). Three State Street ETFs use the phrase “Fossil Fuel Reserves Free” in their names. They exclude companies that own “proved and probable coal, oil, and/or natural gas reserves used for energy purposes” but still have overall fossil-fuel exposure ranging from 4.3% to 7.4%.
Investors sometimes formulate their own definition and timeline, depending on broader market issues. In an article published recently by an ETF trade publication , the massive surge of inflows into the iShares ESG MSCI U.S.A. ETF /zigman2/quotes/208081415/composite ESGU -1.74% was described as a response to “cratering oil prices” in early 2020. But there’s nothing especially “ESG” about the fund’s makeup.