With big-name critics hurling insults amid lacklustre performance, environmental, social, and governance (ESG) investing has hit an "unfavourable inflection point." That's according to analysts at CIBC Capital Markets who warn the flow of funds into the loosely-defined, do-good theme could turn negative over the summer for the first time since 2018.
CIBC says shares of Canada's six largest banks could benefit, and the tech sector may be at risk, as investors ditch a "lemming-like focus on broad/aggregated third-party [ESG] scores," for a more nuanced view less focused on emissions.
The latest salvo of ESG criticism includes Tesla (TSLA) CEO Elon Musk, who last month called the acronym a "scam" that's been "weaponized by phony social justice warriors." His remarks came after the electric automaker was ousted from the S&P 500 ESG Index. More recently, BlackRock (BLK) CEO Larry Fink, a vocal supporter of climate-focused investing, says asset managers shouldn't be responsible for ensuring their portfolio firms are doing their part to protect the planet. He adds that he doesn't want the private sector to be "environmental police." There's also the "greenwashing" scandal unfolding at Deutsche Bank that's led to executive departures, and the reported suspension of HSBC's head of responsible investing over comments downplaying climate change.
Adding to the tough times for ESG, the Impact Shares MSCI Global Climate Select ETF (NTZO), launched in November at the United Nations' COP26 summit in Glasgow, is now set to close after backers failed to provide anticipated funding.
"This should not be surprising. ESG funds are overweight technology and 'new energy' entities (many of which are growth names), and underweight energy," Merwat wrote in a recent research note. "As such, the inflation trade has been a headwind for relative performance across ESG funds."
CIBC estimates total ESG mutual fund and ETF assets under management fell to US$1.6 trillion as of May 31, a decrease of 13 per cent from a peak at the end of last year. According to the bank, in the first five months of 2022, flows into ESG funds have totalled US$100 billion, down 60 per cent year-over-year. May's reading of US$2 billion was the second-lowest month in the last four years, according to the analysts.
"Only COVID's March 2020 drawdown was worse. If flows go negative over the summer, it would be the first negative reading since September of 2018, which saw large outflows of equities generally [at the] height of Trump's trade war," Merwat wrote in the report.
Which are the best ESG stocks for 2022?
CIBC says the financial sector will be the most likely winner amid a shift to "new ESG" thinking less narrowly focused on carbon emissions. All of Canada's six largest banks are participating in sustainable finance initiatives, have pledged net-zero targets, and are looking to cut carbon intensity across their loan books.
Canada's Office of the Superintendent of Financial Institutions has also drafted guidelines to introduce mandatory climate-related financial disclosure around the Task Force on Climate-related Financial Disclosures, along with capital and liquidity buffers around climate risk.
"We believe the Canadian Banks should screen as some of the best ESG names in the domestic market," Merwat wrote. "Firstly, they are Canada's largest entities and have the best chance of screening into a global ESG fund. Secondly, they have some of the highest levels of profitability amongst their peers with an outstanding long-term record of consistent dividend hikes. They are the largest employers in Canada. They are also the largest tax payers in Canada."
TD Bank (TD.TO)(TD) ranked number four on CIBC's list of financial equities that saw the most buying from ESG funds in the first quarter of 2022. Royal Bank (RY.TO)(RY) and CIBC (CM.TO)(CM) ranked 29 and 52, respectively, on the list of over 1,700 financial equities.
Which are the ESG stocks most at risk for 2022?
Meanwhile, CIBC says technology stocks have enjoyed the "ESG benefit of the doubt" due to their carbon emissions-light business models and large size, factors which have helped them screen into many ESG funds. However, the tech sector's social and governance challenges place it "most at risk" amid a shift in ESG thinking, according to the analysts.
The bank points to "regulation (antitrust, privacy, mental health, etc.), profit shifting and tax avoidance, large insider stakes and/or unequal voting rights, or lack of employment in communities (i.e., automation, cloud-based services)," among the risks facing the large-cap technology companies that feature prominently in many ESG funds today.
Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.