(Bloomberg) --

ESG investment strategies have been widely criticized this year, so much so that money is leaving the once-thriving part of the asset management industry.

Analysts at Bloomberg Intelligence estimate $2.3 billion was pulled from US-based ESG, sustainability and values-oriented exchange-traded funds during the first half of 2023. The withdrawals were largely driven by one fund: BlackRock Inc.’s iShares ESG Aware MSCI USA ETF (ticker ESGU), an index fund designed to track companies seen by MSCI Inc. as having positive environmental, social and governance characteristics.

In the first half, roughly $7 billion exited ESGU, reducing the fund’s assets to $12.2 billion. Additionally, clean energy funds have seen inflows turn to outflows this year, with about $1.1 billion withdrawn from the sector in the same period, according to Shaheen Contractor, senior ESG strategist at Bloomberg Intelligence.

Add it up and there’s little doubt the political backlash against ESG, led by Republican presidential candidates Ron DeSantis and Vivek Ramaswamy, is starting to have some impact.

But money managers at Neuberger Berman argue that sustainable investing isn’t going away—no matter the politics. And without talking about any of their competitors, they say the best way to play the market is via actively managed funds, not ESG-labeled index-tracking portfolios.

Their reasoning goes something like this:

  • The virtues sought by sustainable investors aren’t possible to identify “in a rules-based, passive strategy” because sustainable investing requires “fundamental judgment.”
  • ESG data is often patchy and incomplete, requiring money managers and analysts to fill the gaps with their own inputs.
  • Decisions about the relative importance and weighting of particular investment considerations and metrics vary from company to company, so more hands-on, qualitative research is required.
  • And finally—and perhaps most importantly—providers of index funds are typically one step removed from really engaging with corporate executives, while active stewardship is the cornerstone of hands-on fund management.

“Analyzing and assessing potential investment opportunities requires qualitative judgment and close relationships built through long-term shareholder engagement,” says Daniel Hanson, Neuberger’s head of US sustainable equities. In a nutshell, this means sustainable investing is “inherently an active-management discipline,” he says.

And the numbers show the $1.3 billion Neuberger Berman Sustainable Equity Fund (NBSLX) has slightly outperformed ESGU over the past three year, with an annual return of 10.6%. ESGU gained at an annual rate of 9.8% in the same period.

ESG-based investing has gained in popularity in recent years as increasing numbers of shareholders and bondholders recognize that environmental and societal issues can be financially material to companies’ bottom lines. But as the industry has grown, so has the number of detractors—especially those in the US Republican Party seeking to protect the fossil fuel industry, the primary driver of the climate crisis.

According to Hanson, some of that skepticism is justified given that a big part of the ESG industry has, in effect, commoditized the investment process, making buyers think “they’re getting something that they aren’t.”

This is the main reason why “we’re skeptical that systematic, rules-based, passive approaches of ESG-integration can be as successful as active approaches,” he says.

Sustainable businesses have specific markers and some are quantifiable, Hanson says, like high levels of cash flow, strong balance sheets, infrequent labor disputes and low carbon emissions relative to peer groups. Other attributes are less clear-cut and require qualitative judgment that index fund managers can’t consistently provide.

“There are many intangibles when it comes to uncovering companies that have a truly sustainable competitive advantage and a strong corporate culture,” he says.

Hanson contends that a critical part of this process is proper engagement with corporate management. While index fund providers often have stewardship teams that meet with company officials, they rarely press for real, consequential change, he says.

“By contrast, we can point to numerous examples of constructive engagement yielding positive results,” Hanson says.

For example, Neuberger pressed Texas Instruments Inc. on improving its “know-your-customer” processes. The company has acknowledged the importance of advanced KYC governance and communication, and it’s something “we will continue to monitor,” Hanson says.

“We rarely tell boards or management what they should be doing at the operating level,” he says. “Instead, we want them to report the right things in a standardized way so that we and other active managers can assess their strategy and progress.”


©2023 Bloomberg L.P.