Alexander Zhang
Sustainable investing combines environmental, social, and governance (ESG) factors with traditional fundamental and technical analysis to provide an effective balance of value and growth which, in theory, should provide outsized returns over the long term due to the future-proof nature of the strategy.
Unfortunately, this has not been the case, with global ESG funds underperforming major indexes in the past five years, returning 6.3% per year on average, compared to 8.9% for broader funds (White and Pham). This has been caused by poor risk management and an unbalanced mix of conventional trading strategies and modernized ESG research methods. ESG funds often fail to provide the returns they promise due to this ESG/value/growth imbalance.
However, this is not a surprise–as with any other novel trading strategy, there are a plethora of complex variables and values that need to be statistically analyzed and manipulated before a functional system is achieved. Clearly, the investment firms of today have not yet found such a system, which has culminated in the lackluster results seen industry-wide over the years since the strategy’s inception. Sustainable investing proves to be a difficult task–while previous investment research mainly focused on logical and understandable ideas such as business models, financials, management, and others, these particular strategies involve yet another irregular component–ESG factors.
The ideas that form ESG–environmental, social, and governance, are ridiculously abstract and present a difficult challenge to study. By what metrics would one judge a company’s environmental, social, and governance impact? This is the question that has been answered incorrectly over and over again. The worst part is that even if a correct answer is achieved, sustainable investing may remain an unprofitable venture, as firms will need to consistently analyze the most important qualities in ESG investing and develop a strategy that can correctly pair the right elements of ESG with the right elements of traditional equity research and analysis.
Oftentimes, this becomes too much to ask, and companies abandon their ESG funds, leaving them to underperform for years on end. The sheer amount of data, analysis, and research that needs to happen in order for a profitable and sustainable investing strategy to be reached is astonishing and unattainable for many companies. However, there are still thousands of investors, retail and institutional alike, that are continuing to dig for gold in the sustainable investing space; it’s up to you to decide if you want to become one of them.
Comments