The False Narrative on ESG Asset Flows
Data has shown that investment strategies that address environmental, social and governance (ESG) issues constitute a third of professionally managed U.S. assets. That has led some to claim that asset prices have been driven up to the point where investors should expect poor performance going forward.
That narrative is false because it relies on what I consider to be an overly broad definition of an ESG asset.
The AUM of assets addressing ESG issues depends on how one defines that universe. A constrained definition – one which I consider reasonable – shows that those assets are much less than what is claimed on an absolute and relative basis.
I have been guilty of perpetuating that false narrative, as have been other authors whose articles have appeared in Advisor Perspectives.
A prominent source of that narrative is the US SIF Foundation’s widely followed biennial report, which stated that one third of U.S.-domiciled, professionally managed assets addressed ESG considerations as of the end of 2019, either via ESG incorporation or filing or co-filing shareholder resolutions on ESG issues. Of the $51.4 trillion in total U.S. assets under professional management, the report claimed that there were $17.1 trillion using sustainable investing strategies.
If one-third of professionally managed assets were following the same strategy – be it addressing ESG issues or any other – it would likely represent what researchers call “overgrazing” – too many dollars chasing too few securities, driving prices above their intrinsic value and depressing future returns. Though the US SIF Foundation does not directly discuss performance in its biennial report, it does provide a list of studies and meta-studies demonstrating the strong performance of ESG funds in recent years.
Claims of overgrazing have been made against value investing and other quantitative strategies, but it is difficult to measure asset flows to a strategy, and most overgrazing claims remain an unproven theory.
Nevertheless, asset flows matter, and it is critical to understand the limits of any strategy. Other than a global, market-capitalization-weighted portfolio, every strategy has an asset limit beyond which returns will suffer.
David Snowball, the editor of the Mutual Fund Observer, raised this issue. He is also a professor at Augustana College, where he has been teaching statistics as rhetorical tools for the last 40+ years. In an email correspondence, he called the global estimates of ESG assets, “laughably unreliable.” He wrote, “Social problems are most compelling when they have a number attached: the number of abused elders, homeless people, missing children, victims of stalking, undocumented immigrants. Numbers make problems real for us. People involved in causes know that, and they know they need to find the ‘right’ number ... and so they do.”