“Not everyone likes ESG” is how Bloomberg columnist Matt Levine titled a recent column in which he discussed pro-ESG arguments and then went on to detail the case of Unilever, which one fund manager said had “lost the plot” because of its fixation on ESG. “Unilever seems to be labouring under the weight of a management which is obsessed with publicly displaying sustainability credentials at the expense of focusing on the fundamentals of the business,” wrote the head of Fundsmith Equity Fund, Terry Smith, earlier this month as quoted by the Financial Times. And he’s not the only one who has a problem with an excessive focus on ESG.
Another FT report from this month cited fund industry insiders as saying some managers were less than thrilled with the wave of ESG washing over the industry. According to the report, a growing number of passive funds are including ESG requirements for the companies they track because of the flow of investment into ESG-aligned businesses.
The trend has gathered so much momentum that some of Europe’s biggest ETF providers are changing the indices that some of their products track. These include iShares, BNP Paribas, and DWS, and they are causing some resentment among fund selectors as they cut off access to companies such as Shell.
According to one industry source the FT spoke to, this resentment is not a common sentiment, but it’s not unheard of, either. “I can understand that some investors are concerned when ETF promoters change the underlying indices of their ETFs since they may have a different investment objective than that of the new index,” Detlef Glow, a senior executive at Refinitiv Lipper, told the FT.
It’s easy to see how an investor’s objective could differ from that of a fund provider right now. Energy has become the top-performing industry on the stock market in the United States, and it’s not because of the influx of EV makers that listed in droves in the past couple of years. It’s because of the oil price rally.
The energy segment of the S&P 500 rose by a combined 46.3 percent last year, versus 24.3 percent for the overall index, according to data released in December. But that’s not all. The Energy Select Sector SPDR Fund gained 46.60 percent between January and mid-December 2021, and the SPDR S&P Oil & Gas Exploration & Production ETF recorded a massive 64.31-percent gain in the period. Clearly, not everybody likes ESG. But everybody likes good returns.
In his column, Bloomberg’s Levine detailed the main arguments in favor of ESG requirements, the most plausible of which from a practical perspective is that while shifting to ESG priorities might affect profits negatively in the short term, it would secure long-term profitability. And yet, too much of a focus on ESG might not be advisable as the Unilever case suggests.
“Unilever seems to be labouring under the weight of a management which is obsessed with publicly displaying sustainability credentials at the expense of focusing on the fundamentals of the business,” Terry Smith wrote.
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The same could be said about a lot of companies, although whether all of them are neglecting the fundamentals of their business is a separate question. Yet especially in energy, we are seeing a massive effort on the part of European supermajors to greenify their business even if they continue drawing criticism from environmental organizations—and activist—in this case, meaning ESG—investors, for not doing enough. And yet, their share prices have been on the rise, not in tune with their ESG commitments but in tune with oil price changes.
It’s easy to see why fund providers would rush to ESG—the media are talking about little else these days. But, according to the FT report, they have overdone it a bit by not informing fund selectors they would be switching indices, possibly assuming everyone would be happy with the switch.
“Fund selectors hate funds being changed without prior warning,” Chris Chancellor, senior director of global insights at Broadridge, told the FT. “For [a fund] to change without prior warnings and conversation means [selectors] may have a fund that doesn’t fit with the reasons they added it to the portfolio.” “Change with little warning creates a trust issue,” he said, adding, “If a change is forced on [a client] at short notice, that doesn’t feel like a partnership and you lose trust that is hard to build in the first place.”
It seems the investment industry has a slight problem of a remedy showing the potential to be worse than the disease. With the global focus on a changing climate and how to slow down the change, it is no wonder a lot of investors are buying into the “Lose now, but save later” argument in favor of ESG. But, as Fundsmith’s Smith says, companies shouldn’t lose the plot because of overfocusing on ESG. If that happens, the business begins to suffer, and that suffering could become chronic.
By Irina Slav for Oilprice.com
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