Investing with a ESG focus (Environment, Social and Governance) apparently has many pluses. However, before you take action you should also carefully consider some potential minuses in connection with investing in ESG funds. Below is a list of few items to consider:
Higher Costs: Investing into ESG requires additional resources from investors if investing is outsourced to a fund manager. Money needs to be spent on buying ESG ratings from data providers. Furthermore, staff needs to be hired to evaluate the data, which typically requires expensive data scientists.
Inconsistency in Ratings: There are many providers that sell ESG ratings for stocks and no ultimate authority or unified way to measure. Unfortunately, in many cases the same company ranks high on ESG metrics in one data set while low in another. This typically happens with heavy industry companies which may pollute the environment, but also have a strong focus on treating its employees well and investing in its local communities. Moreover, the risk of green-washing is eminent.
Higher Fees: ESG products charge higher management fees than plain beta ETFs, which have become almost zero-cost (see also Higher Costs). However, it is expected that fees will come down as ESG funds will become more mainstream.
Stakeholder Approach: Companies that rank high on ESG pursue a stakeholder, not a shareholder approach. Naturally this implies that resources that could have been distributed to shareholders as e.g. dividends are allocated elsewhere.
Structural Sector Bets: Certain sectors like energy rank structurally low on ESG given industry characteristics, which implies that investing in ESG strategies results in sector biases/ decreased portfolio diversification. Specifically, this results in a structural overweight in technology and underweight in energy stocks. On the other hand, that is exactly the point?
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