US ESG Funds Failing to Outperform on SDG Impact

Sustainable equity funds exposed to similar constituents and impacts as vanilla counterparts due to lack regulatory definitions, study finds.

US equity funds marketed as sustainable are having a weak and barely more positive impact on UN Sustainable Development Goals (SDGs) than vanilla funds, and are even negatively impacting environmental SDGs.

A new report from sustainable investment data provider Util – ‘How SDG aligned is ESG?’ – compared the respective listed company holdings of 281 US sustainable funds with those held in the total US-domiciled fund universe and evaluated the degree to which each group positively and negatively contribute to the 17 SDGs.

It found that without “regulation dictating what constitutes ESG investing, nor how it should be integrated and addressed, funds marketed as ‘sustainable’ are commonly exposed to the same constituents as their vanilla counterparts”.

A recent Europe-focused Morningstar study found similar carbon footprints and fossil fuel exposures across funds marketed as green and those with fewer or no environmental credentials.

Negative investment impact on planet

The SDGs are a collection of 17 interlinked global goals designed to be a “blueprint to achieve a better and more sustainable future for all”. Established in 2015 by the United Nations General Assembly, the goals are intended to be achieved by 2030.

The Util study divided the SDGs into three subcategories – prosperity, people and planet – and evaluated every listed company’s contribution to each as an aggregation of its products and services, weighted by revenue and scored according to peer-reviewed conclusions.

Due to the overlap in holdings, the aggregate impacts of the US total and sustainable fund universes were very similar. Both fund groups had a mildly positive impact on the four ‘prosperity’ goals, a slight positive impact on the eight ‘people’ goals, but a negative impact on the five ‘planet’ goals.

While 77 of the sustainable fund names contain the terms ‘green’, ‘clean’, ‘climate’, or ‘sustainable’, only four had a positive impact on the environmental SDGs.

Util concluded that greenwashing was “rife” with sustainable funds hardly deviating from the mean despite a higher average fee of 43%.

“Relative goodness doesn’t translate into positive impact,” the report said. “With all SDG performance aggregated, the sustainable fund group performs just two percentage points higher than the benchmark—for which end-investors pay a premium. Investors claim to be ESG, but there’s little mandate to match words with action or intent with impact.”

Unexpected relationships

Util used machine-learning models to analyse peer-reviewed academic publications to extract positive and negative relationships between a company’s products and services and the 169 UN SDG targets, as well as 2,000 sustainability themes. The models examined the publicly disclosed revenue streams of all 45,000 of the world’s listed firms and drew conclusions from 120 million peer-reviewed journals.

“Util’s machine-learning models discovered relationships between ostensibly uncorrelated investments and SDGs. Sustainable funds are more likely to focus on female-led businesses but don’t outperform on SDG 5 (gender equality) because they fail to invest in female welfare globally. They’re underexposed to healthcare but outperform on SDG 3 (good health and well being) because they’re overexposed to transport and underexposed to energy.”

Util stressed that to achieve positive impact and avoid unintended pitfalls, portfolios must have a clear objective, address all potential outcomes, and consider the full value chain of any sustainability theme.

“We have less than a decade to meet the SDGs,” it said. “Capital allocation is a critical lever. We can, and must, do better.”

A number of recent studies have questioned the effectiveness of ESG-labelled funds, both in terms of their impact on SDGs and the goals of the Paris Agreement.

In a report earlier this year from ESG Observatory only 207 of 549 (41%) ESG-labelled ETFs were found to be aligned with any one of the SDGs.

ESG ETFs that are aligned with an SDG are largely focused on ‘climate’ or ‘diversity and inclusion’, leaving goals such as ‘good health and wellbeing’ and ‘no poverty’ under-represented.

More recently, a report from InfluenceMap found that 55% of 130 climate-themed funds, with titles such as ‘low carbon’, ‘fossil fuel free’ and ‘green energy’, had a negative Paris Agreement alignment score.

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