Determining how best to incorporate environmental, social and governance factors across the investment portfolio continues to be a challenge for institutional investors, said Bonnie Treichel, founder and chief solutions officer at Endeavor Retirement, during the “Surveying the Landscape” session of CIO’s ESG livestream this month.

Not Just a Label

“How do people really understand this?” Treichel asked. “It’s really hard, because a lot of times, I’ll ask the question about ESG and an investment lineup, and the perspective that I hear is, ‘Well, if it doesn’t say ESG in the title of the fund, or if it’s not named that, or if it doesn’t say sustainable, then we don’t have ESG in our lineup.’”

Treichel continued to say that true ESG integration, defined by the CFA Institute as ongoing consideration within an investment analysis and decisionmaking process with the aim to improve risk-adjusted returns, requires more knowledge about a fund or strategy than its title to avoid “greenwashing.”

“Distinguishing between something that has been greenwashed versus what has actual signs of integration really takes rolling up their sleeves and doing the work,” said Treichel. “I think that is really one of the big problems.” It is key to have “access to the tools and resources to be able to get the real issue,” she added.

Sustainable Stock Picking

When it comes to broad equity market investing, ESG stocks are also difficult to define and benchmark, said Witold Henisz, the vice dean and faculty director of the ESG Initiative at the University of Pennsylvania’s Wharton School. But that is not necessarily uncommon in the world of equities.

“It’s very hard to ascertain what is an ESG stock in the same way as it is hard to ascertain what is the value stock, what is the growth stock,” Henisz said.

The lines get no clearer when it comes to performance of stocks that include ESG factors, which, again, is not necessarily any different from the rest of the market.

Henisz pointed out that research shows no on-average benefit to using an ESG strategy—but that can also be said for many other strategies, as no criteria consistently outperforms the market.

No one can provide “the formula that would help you pick the stocks that would outperform the market over the next five or 10 years—it doesn’t exist,” Henisz said. “Sometimes [it is] value stocks, sometimes growth stocks, sometimes the big industrials, sometimes the emerging markets. ESG is an overlay on top of each of those investment strategies that should allow them to do better.”

Henisz provided the example of the current Russia-Ukraine and Israel-Hamas wars. Fossil fuel stocks are going to outperform, and during that time, ESG stocks, which tend to be more environmentally considerate companies, are going to underperform.

“ESG strategies clearly don’t underperform the market,” Henisz said. “Under some periods, under some strategies, ESG strategies are going to outperform the market, and there are plenty of studies that show that for certain industries, certain years and certain datasets. Would you ever want to take that ability away?”

Henisz concluded that definitions and standards will be key to navigating the future ESG landscape: “We need to have more regulation to root out greenwash and really set a standard that if you’re going to say you’re doing ESG integration, you’ve got to meet these criteria.”

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