Sustainable investing is a Wall Street myth, ESG funds don’t stop climate change


  • The latest fad in investment concerns environmental, social and governance funds that invest in “responsible” companies.
  • But there is no evidence that ESG funds help mitigate climate change.
  • Investors and the SEC should be wary of thinking that these funds are helping the environment.
  • Bernard S. Sharfman is Associate Researcher at the Law & Economics Center, Antonin Scalia School of Law, George Mason University.
  • This is an opinion column. The thoughts expressed are those of the author.

The modes of investment are not new. For example, in the 1990s the stock market was caught in the dot-com bubble – a wave of massive speculation where investors flocked to all internet-related stocks. Eventually, the fashion faded, the bubble burst, and investors lost about $ 5,000 billion.

The latest fad in investment concerns environmental, social and governance (ESG) funds. The aim of these funds is to invest in “responsible” businesses as a way to promote social change – especially with the aim of mitigating climate change – while at the same time gaining market returns. But the problem with this climate change fad is that there is no empirical evidence to support the idea behind it. Indeed, it seems fairly clear that an investment strategy consisting of overweighting portfolios with securities of companies that produce a relatively low level of carbon emissions has no impact on climate change mitigation. . The world keeps coughing up emissions despite the rapid growth and level of investment in ESG funds.

ESG investing does not mitigate climate change

People who understand ESG data recognize the lack of connection between product popularity and the achievement of their supposed climate change goals. In a recent LinkedIn post by renowned finance professor Alex Edmans of the London Business School, he agreed with my comment “ESG investing does not mitigate climate change”.

In another comment, Ashley Hamilton Claxton, Head of Responsible Investment at Royal London Asset Management, wrote: “ESG data is not data, it is opinions. We cannot and must not claim a direct impact on secondary markets. Investors are a cog. in the wheel that spins the global economy. You cannot change the world or fix climate change by buying and selling stocks and bonds. ”

This understanding is also shared by Bill Gates, Alicia Munnell, professor at Boston College, and former BlackRock Investment Director for Sustainability Tariq Fancy, among others.

The idea behind the impact of ESG on climate change is that by taking money away from companies that spit fossil fuels, the funds can effectively enable “clean” companies to raise funds through ‘loans or shares and more expensive for “dirty” companies. . This sounds good in theory, but does not hold up in reality as the main effects of ESG funds are in the secondary market, where securities are traded but no new money is raised. As Fancy explains, investing in ESG funds does not provide new financing for companies that would help mitigate climate change. “Instead, the money goes to the seller of the shares in the public market.” Basically, ESG products buy shares of companies from other asset managers, not underlying companies, so they do not fund those companies directly at all.

In addition, there are still many investors ready to invest in the securities of high carbon companies, allowing these companies to raise new funds at lower rates. For example, if ExxonMobil, a company attacked for its policy of refusing to engage in low-carbon energy production and lobbying against legislation to mitigate climate change, made a $ 2 billion debt offer. dollars with a 30-year maturity, it would probably only pay an interest rate of around 3% per annum.

So, what is ESG fashion?

If ESG funds do not mitigate climate change, what is the motivation for marketing these funds to investors? The simple answer is that the investment industry, which includes large investment advisers, rating agencies, index providers and consultants, makes a lot more money when investors buy stocks in ESG funds. compared to regular index funds where management fees sometimes approach zero.

Of course, investors have the right to invest in whatever they want, including the latest in investing. However, in doing so, it is important for them to understand that investing in ESG funds will not lead to climate change mitigation. What they get for their money are investment funds with higher management fees and potentially higher levels of unsystematic risk – due to a lack of diversification – compared to comparable non-ESG funds. .

Finally, the SEC is moving forward with a proposed rule that will require a wide range of mandatory climate change disclosures, making it easier to provide ESG ratings and create ESG funds. For this to happen, the SEC must not only determine that it has the legal authority to do so under applicable laws, which I discussed in my recent SEC comment letter, but also whether it wishes to use its discretionary rule-making power. power in this regard.

In making a decision on the use of its discretion, I suspect that at least some of the SEC commissioners will be swayed by the presumption that by requiring mandatory climate change disclosures they will contribute in some way or form. another to mitigate climate change. Incorporating this presumption may prompt such commissioners to test the limits of their legal authority.

However, before doing so, I urge every Commissioner to take a hard look at the empirical evidence – not just the hype that comes out of the investment industry. While they can find good empirical evidence showing that investing in ESG funds offers a significant advantage in mitigating climate change, it may be appropriate, depending on what the law allows, for the SEC to take a broad approach to climate change. its new disclosure rules.

However, I doubt that such empirical evidence actually exists, forcing the SEC to take a more restrictive approach by enacting a new rule on climate change disclosure. In summary, before investors embark on ESG investing and regulators approve new rules that support such investment, I hope all parties will take into consideration that such an investment will not mitigate climate change.

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