By Profit_Image @

At The Wall Street Journal, Akane Otani explains the tendency of ESG Funds (funds focused on investing for environmental, social or governance preferences) to invest in certain types of stocks that may not actually be the best match for the mandate they have been given. The end result may be that these funds are just closet tech funds. He writes:

Companies focused on issues that the environmental, social and governance movement has come to be associated with, such as renewable energy, clean water, and racial and gender diversity, are relatively underrepresented among such funds. For instance, NextEra Energy Inc. is the world’s largest operator of wind and solar farms. It wasn’t on RBC’s list of widely owned stocks in ESG funds. But big tech companies like and Facebook are on the list.

The data point to one of the biggest frustrations critics have about the world of socially conscious investing: There is no industrywide rulebook to determine what should go into ESG funds.

Some fund managers screen out all companies from a certain industry, like oil and gas, and focus on smaller, lesser-known firms at the forefront of areas like clean energy or boardroom diversity. That risks delivering returns that might drastically trail behind the broader market. So the institutions behind the biggest ESG funds often follow another playbook: They try to minimize how much their fund deviates from the broader market by creating a portfolio that, for the most part, looks like today’s technology-dominated S&P 500—just stripped of the companies with the worst ESG practices within each industry.

The result?

“These funds are often invested in stocks that don’t tell the picture of what you might think ESG does,” said Mitch Goldberg, president of investment advisory firm ClientFirst Strategy.

He added investors need to look beyond the “feel-good aspect of ESG” and understand what exactly they are buying.

Many of the tech companies that are among the most popular stocks in sustainable funds have earned high ratings across multiple elements that analysts consider in evaluating ESG practices.

Index provider MSCI Inc. gave Microsoft an “AAA” rating on ESG—the highest possible score, awarded to just 4% of companies in the software and services industry. It cited the company’s strength on privacy and data security, corporate governance, lack of corruption and instability, and clean-tech-innovation capacity.

Yet other companies often included in sustainable funds have struck investors as more controversial choices.

MSCI gave Facebook and Amazon poor ratings on privacy and data security and on labor management, respectively. The two stocks are held by a number of large sustainable funds anyway since they satisfy other criteria. For instance, Brown Advisory’s Sustainable Growth Fund excludes companies that conduct animal testing for nonmedical purposes, own fossil-fuel reserves, derive revenue from “controversial weapons,” or defy the United Nations Global Compact Principles—but doesn’t have in its prospectus any language that disqualifies companies with controversies related to user privacy or labor rights.

Read more here.