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Frontier Asset Management CEO Rob Miller

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Why ESG Investing Is 'a Mess' and What to Do About It

By Janet Levaux

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The world of investing with environmental, social and governance factors is in a shakeup. 

The U.S. market for ESG-related products is now estimated to be $8.4 trillion, according to a study published Tuesday by the US SIF Foundation. That’s roughly half of the $17.1 trillion asset tally this sector had two years ago. 

US SIF, an advocacy group for sustainable and responsible investments, says it changed its methodology, and thus analyzing the numbers for 2020 and 2022 is a bit like comparing “apples and pears,” according to a recent Bloomberg report. 

“The market is clearly taking a more critical eye toward the less robust end of the spectrum, leading to a reset both here and in Europe,” said Rob Du Boff, senior ESG analyst at Bloomberg Intelligence in New York.

For some time, ESG supporters have advocated for the stricter application of its standards and labeling. Meanwhile, there have been “multiple regulatory proposals put forward [in 2022,] as well as accusations of greenwashing and political attacks by some policymakers,” US SIF CEO Lisa Woll told Bloomberg.

Vanguard opted last week to withdraw from the Net Zero Asset Managers’ climate initiative “so that we can provide the clarity our investors desire … and to make clear that Vanguard speaks independently on matters of importance to our investors.”

Earlier in December, Florida decided to pull $2 billion worth of state assets managed by BlackRock, as part of Republicans’ fight with the firm tied to its ESG investing practices. Missouri withdrew some $500 million of pension assets from BlackRock in mid-October, pointing to the firm’s prioritization of ESG concerns over shareholder returns.

To get a sense of what these developments mean for financial advisors and the industry, ThinkAdvisor asked Robert Miller, CFA, CEO of RIA Frontier Asset Management, about changes in this sector and the values-investing work he does with clients. 

THINKADVISOR: The ESG arena seems full of turmoil right now. What’s been going on and what do you see happening next? 

ROBERT MILLER: It is a mess because you cannot standardize someone’s values. The term ESG means many different things to many different people. 

For example, in the investment industry, there is often a wide divergence when it comes to ESG rating criteria among the various providers of company ESG ratings, variations in inclusionary and exclusionary screening criteria within ESG Index construction, and often substantial differences in the makeup and holdings of many ESG investment products currently available. 

Take the Vanguard ESG US Stock ETF (ESGV), for instance, which attempts to exclude fossil fuel investments from its portfolio entirely and had a total allocation to the energy sector of 0.02% as of Oct. 31, according to Morningstar data.

At the same time, the SPDR S&P 500 ESG ETF (EFIV) has several holdings in oil and gas and traditional energy producers like Exxon, ConocoPhillips and Marathon Petroleum Corp, among others. Both are built with ESG in mind, but there can be significant differences in the holdings and resulting risk/return profiles of the investments.

With everything somewhat muddled right now (such as oil firms investing in solar), how can investors really screen for their values?

It is difficult to screen for your values. We recommend investors select several of their top priorities and align their investments with those values. 

This can either be avoiding companies that profit from activities that do not align with your values, such as pornography, or investing in companies you believe are adding value to the world, such as a pharmaceutical company working on cancer drugs.

What exactly is values-based investing, does it include spiritual and/or non-spiritual objectives, and can it include ESG?

It is hard to base an investment on a spiritual objective. Those objectives do not usually offer financial returns. Values-based investing is more about deploying capital to companies you believe are adding value to the world and avoiding companies you believe are removing value or preying on people.

For example, investing in a biotech company researching potential treatments for cancer that can improve the lives of people across the globe, while avoiding investments in large tobacco companies that have contributed to significant smoking addictions among children and teens in the developing world. 

Environment, social, and governance is a common theme through all values-based investing. Investors care about the environment, social impact, and the governance of companies, but they may disagree on the best approach. This makes values-based investing very individualized and creates a need for many different products and ideologies to serve all investors.

How can advisors get started in values-based investing, and how does a down market affect this strategy?

The easiest way to get started is through mutual funds and ETFs. Read about the investment style of the fund or strategy and determine whether it matches your values. There are also third-party screening services that evaluate your funds or individual investments.

It’s been reported that “socially conscious” equity funds have struggled a bit more than the market this year — primarily due to these funds favoring growth stocks, especially tech stocks. That’s why, as with any investment strategy, it’s important to consider how diversified a fund or strategy is prior to investing — and to ask how the fund or strategy manages for downside risk.

Are there any tax implications with values-based investing?

There are always tax implications with changing investments, but there are lots of opportunities to take losses in portfolios with the recent market decline. This makes changing investments or investment managers easier from a tax standpoint right now. 

For example, if an investor wanted to change his or her existing diversified portfolio to a values-based investment strategy, there’s a good chance many of their portfolio holdings will have unrealized losses (assuming they were held prior to the start of the year) that could be realized through selling those positions as they switch to a values-based investment strategy. 

The taxes from assets generated by selling investments at a loss can be used to offset taxes from other investments sold with capital gains. Also, they can be carried forward indefinitely to offset taxes in future years, if they more than offset any gains realized in the current tax year. 

Janet Levaux

@Think_JanetL

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