ESG lessens the small value tilt
Our portfolios have a tilt toward small cap and value stocks. This is based on Nobel prize winning research by Fama and French showing these stocks tend to outperform over the long term. Companies with better ESG ratings are likely to fall into the large cap sector, as it takes significant capital to invest in ESG practices and report on them. Integrating ESG into your portfolio lessens the tilt toward small cap and value stocks. This is increasingly true in our more aggressive portfolios with the most small value tilt.
Statistically insignificant data on risk and returns
Relative to the stock market itself, ESG investing is comparatively new. Many funds are less than 10 years old with new funds being offered all the time. Given this short time horizon, there isn’t enough data to indicate whether the use of ESG ratings in investment portfolios statistically affect return or risk.
ESG screens increase investment expenses
The screens adopted to address sustainability issues are a cost to a portfolio. The weighted-average expense ratio of ESG funds as reported by Morningstar (an independent investment research firm) is 0.63% with 22% of those funds having an expense ratio of 1.0% or higher. For context, our portfolios at Skyline have an average expense ratio of 0.25% .
ESG screens decrease diversification
The exclusion or diminished position of stocks may reduce diversification of the overall portfolio and could result in some high-performing stocks being excluded.2
ESG data is self-reported and there is a lack of standards among rating firms.
There are 7 main providers of ESG ratings: CDP, Trucost, MSCI, Sustainalytics, Thomson Reuters, Bloomberg, and ISS. Each agency relies on its own analysts and algorithms to review the self-reported disclosures of ESG metrics by companies. This results in large discrepancies and a question of quality over self-disclosure.
Research suggests consumer habits are more effective than investing in changing corporate behavior
Buying ESG stock on the secondary market doesn’t have a direct day-to-day impact on the company itself. The more effective way to influence a company’s bottom line is with your purchasing power and where you choose to spend your money.
ESG increases feel-good feelings
Firms that engage in ESG create a sense of purpose and motivation to employees. Investors who own ESG stock feel good about their contributions to the investment landscape.
High ESG affords low cost of capital and more ESG investing
As ESG increases in popularity, it is being reflected in an increase of stock prices for higher scoring ESG companies. As a result, companies with higher ESG ratings can access a lower cost of capital than those with lower ESG ratings (i.e. sell fewer shares into the market to get a given amount of new capital). This easier access to capital lets companies do more — expand into new areas, build new products, and continue their focus on sustainability for a competitive advantage.