3. One important point that we mention in the report—I strongly suspect that ESG ratings don’t track social impact very closely. e.g. a quick glance at Philip Morris’ ESG rating puts it in the 72nd percentile in terms of ESG, meaning that it has the same ESG rating as Kellogg’s, and Philip Morris scores better on social indicators than Kellogg’s. Unless, unbeknownst to me, Kellogg’s use the funds from Crunchy Nut Corn Flakes to make cluster bombs for the Saudis, something has gone awry here. As far as I can tell, Philip Morris’ climate-friendliness and water preservation receives the same weight as its impact on consumer health: making your cigarettes with fair trade solar panels gets you a bump up the ESG ratings.
Re why the market hasn’t moved into SRI, this sort of persistent market inefficiency that would be pretty surprising, and the evidence suggests it is highly unlikely.
4. The trends towards SRI seem less important given that much SRI is not very strict.
Are you saying that your marginal contribution is small, or are you saying that you have a greater contribution by being involved in a wider movement? If the first, then we agree, if the latter, then I don’t see the argument for it.
The key issue is what impact you have compared to what you could do by giving to effective charity. I have yet to see the case that investing through the stock market has anywhere near as much impact as donating to effective nonprofits.
“I have yet to see the case that investing through the stock market has anywhere near as much impact as donating to effective nonprofits.”—where do you believe the post claimed otherwise?
One thing that compliance was very clear on is that I’m not allowed to discuss specific investments in a public forum. I’m sorry I won’t be able to respond to your first point here other than to say that this is why I spend so much time looking at methodologies behind ESG ratings and the way mangers apply them.
The core of our argument is that your last point makes a critical category error: while donating to effective charities will almost certainly generate higher impact, there is a a HUGE amount of capital that cannot be given away (due to being earmarked to funding retirement or other goals), and that impact investing and ESG are tools to have some impact where otherwise your investments could be funding actual harms.
To the point about our involvement with the PRI and other working groups: our argument here is our marginal impact is significantly higher given this involvement. I hope to have an impact report completed soon with more details.
We say in the report that SRI is probably more impactful than socially neutral investing. I don’t think that SRI in stock markets is particularly impactful however, and I think it would be bad if foundations started doing it for the sake of impact.
If you spend so much time looking at ESG methodologies, and you need to do this to have social impact, then this is an additional cost of SRI, and a reason to expect you to get lower returns than someone who doesn’t care about impact.
in my view, foundations should be doing ESG investing from a risk management perspective, not an impact perspective. Foundations should examine Impact Investing for a portion of their endowments as both a risk mitigation factor and from an impact standpoint. it’s important to differentiate the two approaches. see my blog post on the topic.
the time I spend reviewing ESG methodologies is part of our Due Diligence process. I think it is fairly uncontroversial to state that any investor should have a Due Diligence process, and should, at a minimum, read and understand the prospectus of an investment and have a discussion with the portfolio manager.
I would welcome the opportunity to show you the portfolios I build, and talk about our manager selection process in more depth. Here’s my scheduling link: Let’s find a time. I have a lot to say about your last point, none of which compliance would be happy about if I wrote in a public forum.
So your due diligence process takes no more time than a socially neutral investor’s due diligence process, even though the socially neutral investor would not spend considerable amounts of time looking at ESG rating methodologies and how managers use them? Are you saying you bear the same time cost as a socially neutral investor even though you do more work? Why is this?
Worth noting also that index funds don’t have to do due diligence.
it is incredibly naive to think that index funds don’t have to do due diligence. you’re simply shifting the diligence from the manager to the index provider and their methodology. what index does the index fund track? how it it composed? what’s the difference between a market cap weighted index and a factor based index? Morningstar has over 2,200 ETFs in it’s database (which isn’t a perfect way to count—it leaves out a lot and there’s overlap with actively managed ETFs, which I don’t like—but it’s a good place to start).
leading with questions about ESG analysis actually SAVES us a significant amount of time in due diligence, by focusing our efforts on funds that we’d actually use. I screen out a lot of providers who can’t answer basic questions from the PRI about ESG integration. Again, I fundamentally believe that ESG analysis improves the security selection process, both in terms of active and passive managers, and can lead to superior risk-adjusted returns.
worth noting that this is an asymmetric process: there are only a handful of reputable (in my opinion) ESG data providers. Once I’ve familiarized myself with their methodology, I only need to keep up with what they’re doing (and select continuing education opportunities to stay on top of the evolution of the industry) and I can get a good feeling for how managers treat this data in conversations with them.
It is, admittedly, very hard for me to compare our DD process with other firms, as we’ve developed it ourselves, and everyone treats diligence differently. I would suspect (but have no evidence) that some advisors do minimal diligence and pick funds based on which wholesaler brings them the best gifts or pays the biggest commissions. would you think this is a better way to approach manager selection?
Yes but obviously index funds have to do much less due diligence—they don’t have to look at the performance of individual companies, nor do they have to look at anything related to ESG. They only have to monitor index composition and things like that, which is less burdensome, much less so relative to the total number of investments you can make .
You initially said ”...this is why I spend so much time looking at methodologies behind ESG ratings and the way mangers apply them.” which suggests to me a significant time sink in the name of impact. Socially neutral investors do due diligence to try and find profit-making companies and so don’t face this burden—presumably you also do due diligence on financial returns? ESG analysis wouldn’t save you from doing due diligence on financial returns, would it?
It is difficult to believe that legions of investors are stupid enough to miss out on the benefits of ESG screening that you allege.