The problem with ESG funds, a portfolio frozen in time, perils of timing the market, and more...
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On average, ESG funds had 68% of their assets invested in exactly the same holdings as non-ESG funds and charged higher management fees while underperforming the market.
A portfolio that was set up in 1935, which bought an identical number of shares in 30 stocks and never made any change, continues to outperform the market.
Investors in index funds underperformed the underlying fund by trying to time their investments.
If history’s any guide, stocks that tend to join the top-10 list of the largest US stocks tend to lag the market after joining.
1. The problem with ESG funds
In April of 2021, BlackRock launched the U.S. Carbon Readiness Transition fund and raised a record $1.25 billion in one day. The fund was created to invest in companies better positioned to benefit from the transition to a low-carbon economy. But, when you dig into its holdings, the fund has invested in Exxon, Chevron, and ConocoPhillips — all of which feature in the top 20 most polluting firms in the world.
A recent study from Harvard Business School found that ESG funds, on average, had 68% of their assets invested in exactly the same holdings as non-ESG funds. Adjusting for this, the average investor is paying 0.63% more fees to invest in ESG stocks. The fund managers love ESG due to its high fees, and given that most investors are buying the fund in the hope of doing good, they are more likely to stick to the investments even if the fund is not doing great.
Finally, an analysis of 2,000+ research papers in 2015 found that slightly more than 50% of the studies found that following ESG principles improved the company's financials. But, only 16% of the studies found evidence of the outperformance of funds investing in ESG.
Most people assume that ESG Investing is designed to reward companies that are helping the planet. In fact, ESG ratings which underlie ESG fund selection are based on “single materiality” — the impact of the changing world on a company P&L, not the reverse.
— Harvard Business Review
2. Winning by doing nothing
The big money is not in the buying or selling, but in the waiting ― Charlie Munger
What if we told you there was a portfolio frozen in time — A fund that was launched in 1935 that picked 30 stocks, bought an equal number of shares in each company, and then never sold or bought any other shares till now?
It held onto the stocks through the World War, Black Monday, the Dot-com bubble, and the Global Financial Crisis without ever selling, and it saw the invention of personal computers, the internet, the iPhone, and even reusable rockets without ever buying into a new company.
As to the question of how the fund has performed, based on our backtest, the fund managed to beat the S&P 500 over the past 30 years while having a better Sharpe ratio and lower volatility.
Between the beginning of 1970 and Nov. 30, 2019, the fund gained an average of 11.1% annually, according to Morningstar Inc.; the S&P 500 returned 10.5% annually over the same period.
It ranks 16th among the 62 U.S. stock funds that have been around since 1970. That’s a stellar result for a fund that doesn’t even have a portfolio manager. — The Wall Street Journal
The fund in discussion is