Environmental, Social and Governance (ESG) investing has been much in the news lately. Three thoughts on this trend.
#1: Global investor interest in ESG is clearly growing.
This is a Google Trends chart showing the volume of global searches for “ESG” over the last 5 years. Interest first started to break out in Q4 2019, rose to fresh highs in January – February 2020, but then took a hit during the pandemic’s first wave. Since September 2020, however, worldwide “ESG” search volumes have made a series of all-time new highs.
In fact, American investors are increasingly looking at ESG as an important factor, similar to “growth” and “value”. This Google Trends chart shows trailing 3-year search volumes for these 3 terms. From lagging in both 2018 and much of 2019, “ESG” (yellow line) is now almost as popular a search as “growth investing” (red line).
Takeaway: Q4 2020 data shows that ESG investing is not the sort of late-bull market fad we so often see at those points in capital market cycles. If you’re looking for “what’s going to actually be different” coming out of the Pandemic Recession, the trend to more attention on ESG investing is a very good example.
#2: There’s a brand new academic paper out from the National Bureau of Economic Research which suggests the increase in ESG-focused assets under management (AUM) is beginning to change how markets price stocks:
- The researchers compared how stocks held by socially responsible (SR) asset managers traded from 1996 – 2003 (i.e. before ESG investing really took off) and from 2004 – 2014 (as ESG AUM grew quickly).
- They found that signals which typically move stock prices (earnings beats/misses, for example) had less of an effect on stocks held by SR managers in 2004 – 2014 than in 1996 – 2003.
- Importantly, the researchers found that ESG scores (like those used by index providers) did not actually predict if a stock would behave differently in the event of an earnings beat/miss. Only stocks actually held by SR managers saw less market reaction.
Takeaway: this is the first work we’ve seen that shows ESG investing is actually changing how markets price individual stocks. The paper’s authors note that ESG stocks held by SR managers don’t ignore good/bad news entirely; it just takes longer for the stock to adjust to the new information. The researchers posit that active SR managers essentially balance a given company’s ESG merits with whatever news flow comes out. A company with a great ESG profile that misses earnings expectations by a few cents might not merit selling, for example. Other managers may sell, but the SR ones will not and that prolongs the time needed to readjust asset prices.
You can read the entire paper here (Cao, Titman, Zhan, Zhang, 2020): https://www.nber.org/system/files/working_papers/w28156/w28156.pdf
#3: Circling back to our initial point that ESG is having a breakthrough moment, some thoughts as to why that is happening right here, right now:
First, the American population has less confidence that its government can solve important problems. Gallup surveys have asked the question “How much trust and confidence do you have in our Federal government in Washington when it comes to handling international/domestic problems?” ever since 1998.
This chart shows the percent of respondents answering “A great deal” or “a fair amount”; it has been cut in half over the last 18 years:
With this view that government cannot or will not act, a growing pool of investors (retail and institutional) see ESG investing as one way to have an impact.
Second, the economic impact of the Pandemic Recession is as close to the Great Depression as most Americans have ever seen. Just as the 1930s was a period of great social change (unionization drives, populist politicians like Huey Long), we should not be surprised that the 2020 version will touch Wall Street. That app-based brokers have pulled more retail investors into the stock market likely plays a role in ESG’s growing popularity as well.
Lastly, and not to be cynical, but ESG investment products carry higher management fees than plain vanilla passive index funds, so there is plenty of incentive on the industry’s part to keep it in the public eye. Marketing socially responsible mutual and exchange traded funds is one way for the money management industry to recoup a small part of the margin it has lost in the 2-decade shift from active to passive products. In fairness, the fee differentials are a pittance compared to how much the overall cost of investing has declined over the last 30 years. We suspect most ESG investors will be fine with paying a few tens of basis points to achieve their goals.
Summing up: it’s not often we get to describe a growth industry in money management, but all the pieces are in place to see ESG continue to take market share from both passive and non-socially responsible approaches to asset management.