Busting ESG Myths with Sustainable Investing Truths
We pull back the curtain on ESG misconceptions to uncover what’s really driving sustainable investment strategies.
Key Takeaways
Sustainable investing, or ESG investing, isn’t about divesting from the oil and gas industry. It focuses on making a “just transition” toward a low-carbon future with green economy jobs.
Sustainable investing strategies are diverse. Some focus on companies with high or improving ESG scores/ratings, while others have specific themes such as “health care” or may exclude companies whose activities violate certain ethical criteria.
Truly sustainable investing isn’t about politics and doesn’t require sacrificing returns. It’s driven by economic considerations and involves assessing how ESG factors impact a company’s long-term sustainability, profitability and shareholder value.
The TV show “MythBusters” tests whether modern-day rumors, claims and cliches hold up to scrutiny. In that spirit, we decided to bust eight environmental, social and governance (ESG) myths we’ve been hearing from clients in the U.S. and explain what we believe sustainable investing really means.
Myth 1: ESG investing is about divesting from the oil and gas industry.
The Truth: For many investors, including American Century Investments, sustainable investing is not about avoiding the energy industry. It’s about making a “just transition” to a low-carbon future.1
Texas will derive more power from renewable sources than oil and gas in about six years, but that doesn’t mean Texas is divesting from the energy industry. Neither are we. See Natural Gas: Friend or Foe?
Myth 2: ESG investing is about excluding investment in certain industries or sectors.
The Truth: Some ESG investment strategies avoid specific activities (i.e., negative screening) because that’s what some investors prefer, but it’s not the most common approach. Sustainable investing strategies may include:
Using negative screening.
Choosing companies with high ESG scores/ratings.
Integrating ESG factors into an overall investment process.
Striving to make a measurable and positive impact by selecting companies aligned with a specific theme or goal.
At American Century, we don’t try to impose our values through investing. We seek to add value by considering factors that affect a company’s long-term sustainability. If an investor wants to exclude specific sectors based on environmental, religious or moral principles, we can accommodate those preferences with customized strategies.
Myth 3: ESG investing is “woke” capitalism that promotes a political agenda.
The Truth: Anti-ESG rhetoric is driven by politics, while sustainable investing is driven by economics. In 10 Reasons Why Truly Sustainable Investing Is Based on Economics, we highlight practical economic reasons to incorporate sustainability into the investment process.
Sustainable investing considers how cost savings, competitive positioning, consumer loyalty and vulnerabilities to potentially costly scandals affect shareholder value. It’s not about being woke — it’s about identifying and addressing real risks to economic growth and profitability that arise from ESG factors.2
Fact: The Center for Audit Quality looked at the most recent (as of June 2022) S&P 500® Index company 10-K filings, finding that 437 (87%) included climate-related information in the risk factor sections of these reports.3 As investors and stewards of our clients’ capital, we believe it’s our responsibility to consider the issues that companies list as risk factors in their 10Ks.
Myth 4: Diversity, Equity and Inclusion (DEI) is about virtue signaling, not shareholder value.
The Truth: The quality of human capital management affects the profitability of businesses in every industry. In a 2022 analysis, international law firm White & Case noted that public companies should consider human capital and labor issues in their annual reports' risk factor disclosure sections. The firm cited risks related to the “ability to attract and retain skilled employees, employee health and safety issues, increases in labor costs, and increased employee turnover.”4
In our view, human capital risk is the largest unquantified risk on corporate balance sheets. In other words, DEI can affect a company’s ability to sustain itself.
Myth 5: People talk about ESG, but no one invests in it.
The Truth: Money moves into sustainable funds in both up and down markets. According to Morningstar® research, when equity markets delivered solid returns in 2021, investors added roughly the same amount to sustainable funds as conventional funds. In 2022, one of the worst years for equity and fixed-income markets in decades, investors pulled money out of conventional funds but continued adding to sustainable funds. See Figure 1.
Figure 1 | Sustainable Fund Flows Compared With Conventional Fund Flows
Data from 1/1/2020 – 12/31/2022. Source: Morningstar Direct, Manager Research.
Myth 6: ESG means sacrificing returns.
The Truth: Sustainable investing is about avoiding potentially costly risks and identifying revenue-generating opportunities. Most ESG-related issues, such as inadequate cybersecurity, violations of environmental regulations that result in fines and penalties, and high employee turnover, can hurt returns. At the same time, innovative companies are finding new revenue sources by appealing to sustainability-minded customers and developing green technologies that could be game-changing.
Some investors may confuse sustainable investing with impact investing, which in its earlier forms often accepted lower expected returns to have a bigger impact. Today, most forms of sustainable investing aim to identify E-, S- and G-related factors that could affect a company’s ability to stay competitive over the long term. Many people now see the goal of identifying these material risks in the investment process as compatible with fiduciary duty.
Because there are several approaches to sustainable investing (see Myth 2), it’s easy to cherry pick data points to support one’s point of view on whether ESG helps or hurts returns. A Charles Schwab study concluded that “ESG has tended to perform very similarly and with very similar levels of risk to non-ESG approaches.”5 Aside from negative screening, which avoids certain sectors by design, sustainable investing doesn’t subtract from returns but has the potential to add to them.
Myth 7: ESG investing isn’t necessary because it’s common sense.
The Truth: Many aspects of running a sustainable, profitable business are related to best practices that management teams and boards should seek to adopt. However, truly sustainable investing applies an in-depth, data-centric approach to identifying and analyzing financially material ESG risks using a wide range of sophisticated metrics and datasets.
As the saying goes, you can’t manage what you don’t measure. Not all companies adhere to best practices, and those that don’t seldom volunteer to disclose these weaknesses (e.g., inadequate cybersecurity, dangerous or inhumane labor practices in their supply chains). Researching a company’s exposure to ESG-related risks can uncover shortcomings and identify businesses that are true leaders.
Myth 8: ESG investing penalizes certain states and hurts their tax bases.
The Truth: If handled poorly, an abrupt, large-scale shift to renewable energy could cost jobs and affect tax revenues. A just transition must include programs to train people for clean-energy jobs.
Still, consumers are insisting on change, and they can’t be ignored. Just 100 years ago, automobiles replaced horse-drawn carriages because consumers demanded them. That meant carriage builders and buggy-whip makers had to find new types of work. Building factories to make electric vehicle batteries, solar panels and wind turbines helps to fight climate change and boost local economies.
Elected representatives should work to attract investments in growing industries to support the tax bases in their areas. It’s already happening in some places, and the momentum is growing. Sustainable investing isn’t just about reducing risks. It’s about increasing opportunities for those who want to reap the potential benefits rather than keep the status quo.
Author
We define “just transition” as a concerted effort to ensure that the important benefits of moving to a green economy are widely shared and that those who may suffer economically from the changes this transition entails are supported.
These factors are often intertwined, not siloed into E or S or G, which is one reason we favor the term “sustainability.”
Center for Audit Quality, “S&P 500 10-K Analysis,” September 1, 2022.
Colin J. Diamond, Maia Gez, Scott Levi, and Taylor Pullins, et al., “Updating Annual Report Risk Factors: Key Developments and Drafting Considerations for Public Companies,” White & Case Alert, November 1, 2022.
Michael Iachini, “How Well Has Environmental, Social, and Governance Investing Performed?” Charles Schwab, September 9, 2021.
Sustainability focuses on meeting the needs of the present without compromising the ability of future generations to meet their needs. There are many different approaches to Sustainability, with motives varying from positive societal impact, to wanting to achieve competitive financial results, or both. Methods of sustainable investing include active share ownership, integration of ESG factors, thematic investing, impact investing and exclusion among others.
Many of American Century’s investment strategies incorporate sustainability factors, using environmental, social, and/or governance (ESG) data, into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider sustainability-related factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh sustainability factors when making decisions for the portfolio. The incorporation of sustainability factors may limit the investment opportunities available to a portfolio, and the portfolio may or may not outperform those investment strategies that do not incorporate sustainability factors. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.
Sustainable Investing Definitions:
Integrated: An investment strategy that integrates sustainability-related factors aims to make investment decisions through the analysis of sustainability factors alongside other financial variables in an effort to make more informed investment decisions. A portfolio that incorporates sustainability factors may or may not outperform those investment strategies that do not incorporate sustainability factors. Portfolio managers have ultimate discretion in how sustainability factors may impact a portfolio’s holdings, and depending on their analysis, investment decisions may not be affected by sustainability factors.
Sustainability Focused: A sustainability-focused investment strategy seeks to invest, under normal market conditions, in securities that meet certain sustainability-related criteria or standards in an effort to promote sustainable characteristics, in addition to seeking superior, long-term, risk-adjusted returns. Alternatively, or in addition to traditional financial analysis, the investment strategy may filter its investment universe by excluding certain securities, industry, or sectors based on sustainability factors and/or business activities that do not meet specific values or norms. A sustainability focus may limit the investment opportunities available to a portfolio. Therefore, the portfolio may underperform or perform differently than other portfolios that do not have a sustainability investment focus. Sustainability-focused investment strategies include but are not limited to exclusionary, positive screening, best-in-class, best-in-progress, thematic, and impact approaches.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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