Environmental, social, and governance investing can have a lot of benefits, but higher returns is not one of them, according to AQR Capital Management founder Cliff Asness.
In his latest blog post, Asness says those who promote so-called negative screening avoiding or divesting bad stock holdings as a means to make more money over time are mostly wrong and actually at odds with the very point of ESG investing.
ESG investors should view smaller gains as the way to bring about the change theyre seeking in the world, according to Asness. Blacklisting sin stocks by definition does not help performance. If removing such shares from a portfolio does help, he says, theyre not constraints as its the action that would be taken anyway for the sake of higher returns.
Pursuing virtue should hurt expected returns, he wrote in the blog. Accepting a lower expected return is not just an unfortunate ancillary consequence to ESG investing, its precisely the point.
As Asness explains, constraints are needed to push investors to do things they otherwise wouldnt out of self-interest.
By default, he said, an ESG investor who screens out certain assets is going to earn less, and the slimy sin investor is going to earn more, than either would in the absence of the ESG investors portfolio constraints. But this is exactly how the ESG investor makes an impact, according to Asness.
If the virtuous decide they wont own something, the sinners then have to, and they have to be induced to through getting a higher expected return than otherwise, he said. This in turn is achieved through a lower than otherwise price.
This hurts the sinful company, which will have to use a higher discount rate or cost of capital in new investment projects in order to deliver that higher expected return. Sinful projects become less profitable, and fewer are undertaken the exact outcome desired by ESG investors, according to the blog.
This might be a painful reality to swallow for the virtuous, Asness wrote. To get precisely what they want, which is less of the bad stuff occurring, they have to pay the sinful investors in the form of a higher expected return.
While all of this sucks, investors hoping to make a positive impact will simply have to embrace the suck, according to Asness.
Thats because without it there is no effect on the world, no good deed done at all, he said. Perhaps this necessary sacrifice is why its called virtue.