Big Technology Stocks Dominate ESG Funds
February 10 2020 - 4:59AM
Dow Jones News
By Akane Otani
Funds that market themselves as sustainable investments aren't
necessarily focused on companies that fight climate change, develop
wind turbines or promote diverse boards.
Instead, many of them look a lot like a portfolio of big
technology stocks.
The five most commonly held S&P 500 stocks in actively
managed sustainable equity funds last fall were Microsoft Corp.,
Alphabet Inc., Visa Inc., Apple Inc. and Cisco Systems Inc.,
according to an RBC Capital Markets analysis.
Companies focused on issues that the environmental, social and
governance movement has come to be associated with, such as
renewable energy, clean water and racial and gender diversity, are
relatively underrepresented among such funds. For instance, NextEra
Energy Inc. is the world's largest operator of wind and solar
farms. It wasn't on RBC's list of widely owned stocks in ESG funds.
But big tech companies like Amazon.com and Facebook are on the
list.
The data point to one of the biggest frustrations critics have
about the world of socially conscious investing: There is no
industrywide rulebook to determine what should go into ESG
funds.
Some fund managers screen out all companies from a certain
industry, like oil and gas, and focus on smaller, lesser-known
firms at the forefront of areas like clean energy or boardroom
diversity. That risks delivering returns that may drastically trail
behind the broader market. So the institutions behind the biggest
ESG funds often follow another playbook: They try to minimize how
much their fund deviates from the broader market by creating a
portfolio that, for the most part, looks like today's
technology-dominated S&P 500 -- just stripped of the companies
with the worst ESG practices within each industry.
The result?
"These funds are often invested in stocks that don't tell the
picture of what you might think ESG does," said Mitch Goldberg,
president of investment advisory firm ClientFirst Strategy.
He added investors need to look beyond the "feel-good aspect of
ESG" and understand what exactly they are buying.
And many of the tech companies that are among the most popular
stocks in sustainable funds have earned high ratings across
multiple elements that analysts consider in evaluating ESG
practices.
Index provider MSCI Inc. gave Microsoft an "AAA" rating on ESG
-- the highest possible score, awarded to just 4% of companies in
the software and services industry. It cited the company's strength
on privacy and data security, corporate governance, lack of
corruption and instability, and clean-tech-innovation capacity.
Yet other companies often included in sustainable funds have
struck investors as more controversial choices.
MSCI gave Facebook and Amazon poor ratings on privacy and data
security and on labor management, respectively. The two stocks are
held by a number of large sustainable funds anyway since they
satisfy other criteria. For instance, Brown Advisory's Sustainable
Growth Fund excludes companies that conduct animal testing for
nonmedical purposes, own fossil-fuel reserves, derive revenue from
"controversial weapons," or defy the United Nations Global Compact
Principles -- but doesn't have in its prospectus any language that
disqualifies companies with controversies related to user privacy
or labor rights.
"What's considered a good ESG stock is in the eyes of the index
provider, " said Todd Rosenbluth, head of ETF and mutual-fund
research at investment research firm CFRA.
There are more niche ESG funds out there. For instance, State
Street Global Advisors' SPDR SSGA Gender Diversity Index ETF, which
trades under the ticker "SHE," comprises shares of large companies
that have at least one woman on their boards or as chief executive.
Invesco's Solar ETF exclusively holds companies in the solar-energy
industry, like SolarEdge Technologies Inc. and First Solar Inc.
But such funds have attracted paltry inflows compared with ESG
offerings that are more closely aligned to the S&P 500.
"It's easy to look at an ESG ETF and see often Microsoft, Apple
and other companies that any other investor might have within their
traditional part of their portfolio, and then you wonder what's the
extra benefit," Mr. Rosenbluth said.
The fact that definitions of ESG can vary so much from firm to
firm has caught the eye of the Securities and Exchange Commission.
The agency has sent letters to companies asking advisers how and
what they determine are socially responsible investments, The Wall
Street Journal reported last year.
Republican SEC Commissioner Hester Peirce has criticized not
only the ESG movement but also the way that companies produce ESG
ratings and scorecards -- saying in a June speech that "ESG is
broad enough to mean just about anything to anyone."
So far, the lack of standardization across the
sustainable-investing world hasn't dissuaded investors from pouring
money into such funds.
Sustainable funds in the U.S. pulled in a record $21 billion in
2019, according to Morningstar Inc., nearly quadrupling their net
inflows from 2018.
Write to Akane Otani at akane.otani@wsj.com
(END) Dow Jones Newswires
February 10, 2020 05:44 ET (10:44 GMT)
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