The foreshadowing of several high-profile scandals highlights the defensive potential of ESG ratings
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Revelations of a voter-profiling firm improperly obtaining data from tens of millions of Facebook accounts sent shares in the social-media giant tumbling last month. This caught many investors unaware, but a handful of funds were spared thanks to a seemingly prescient ESG-focused report.
“[Analysts at index provider MSCI] wrote in a June report that Facebook was ‘exceptionally vulnerable’ to backlash from users and regulators because of its focus on ‘monetizing personal information,’” reported the Wall Street Journal. “In fact, MSCI has singled out privacy practices as one of its biggest risks since Facebook went public in 2012.”
As per the Journal report, fund managers that heeded the warning took in smaller-than-usual slices of the company. This has allowed them to beat major US stock indexes, which were dragged down as Facebook sank 6.8% so far this year.
But investors that steered clear of Facebook over ESG concerns may have also missed out on stellar gains it logged beforehand. “You’re taking the risk of missing out on short-term supernova performance gains, but you’re trying to insure your portfolio against companies that are liable to implode,” said Martin Kremenstein, head of retirement products and ETFs at Nuveen, the asset-management arm of TIAA.
Nuveen, as well as US-based BlackRock and Oppenheimer Funds, offers funds that have been pegged to ESG indexes. Other money managers incorporate ESG scores in more active stock-picking strategies.
ESG ratings, an offshoot of socially responsible investing, reflect an increasing interest in systematically evaluating business rather than simply excluding unlovable industries. Analysts at rating firms like MSCI, Sustainalytics, and Thomson Reuters determine the scores by scouring news stories, financial records, and company reports for industry-related risks that might not be evident from traditional financial analysis.
The Equifax data breach in 2017, which resulted in massive outrage and plummeting share prices for the company, came a year after the firm was dropped from a family of MSCI indexes because of prior data-security lapses. MSCI also slashed Wells Fargo’s ESG score in 2015, citing a high level of customer-service complaints; months afterward, the company was sanctioned for “widespread illegal” sales practices.
But “[w]hether those judgments will translate to better returns over the long haul isn’t entirely clear, in part because there’s no fixed definition of what constitutes an ESG fund,” the Journal said. According to Kremenstein, there’s evidence that such strategies may fall behind hot stocks during runaway bull markets, but will be hardier in a downturn.
