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Home Investments

The illusion of ethical investing: Can finance truly save the world?

Hezron Mwangi by Hezron Mwangi
December 19, 2024
in Investments
Reading Time: 2 mins read

Ethical investing, often branded as Environmental, Social, and Governance (ESG) investing, has surged in popularity over the past decade. Proponents claim it allows investors to align their portfolios with their values while still making profits. However, as the hype grows, it becomes increasingly clear that ethical investing may be more of a fad than a sustainable shift in financial markets.

One major issue lies in the vagueness of ESG criteria. Companies are often labelled as “ethical” based on arbitrary metrics. For instance, a multinational company could be praised for reducing its carbon footprint while still exploiting cheap labor in underdeveloped regions. These contradictions expose ethical investing as more of a marketing strategy than a meaningful solution to global issues. A 2023 report by morning star found that over 50.4% of ESG funds outperformed the market simply because they excluded high-risk sectors like fossil fuels, not because they drove real change.

Further, ethical investing is a privilege that may not address the core problems it claims to solve. Investors in developed economies can afford to screen out “unethical” industries, but for developing nations like Kenya, such decisions can have severe economic consequences. Industries like mining, manufacturing, and energy – often excluded from ESG portfolios – are vital for Kenya’s growth. A blanket dismissal of such sectors under the guise of ethics could stunt progress and exacerbate poverty.

Moreover, ethical investing often underperforms traditional investment strategies. ESG funds have consistently underperformed. When comparing a typical large ESG Exchange traded fund (ETF) to its benchmark, a marginal underperformance becomes evident. For instance, the iShares ESG Aware MSCI USA ETF aims to mirror the performance of the MSCI USA Index, albeit with a preference for companies with favorable ESG ratings. As of the end of March 2024, the iShares ESG Aware MSCI USA ETF reported total annualized returns of 14.7% over the past 5 years, respectively. In contrast, the ETF’s benchmark, the MSCI USA Index, delivered total annualized returns of 15.0% over the same period. Investors who prioritize ethics over profits risk undermining their financial goals.

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The reality is that financial markets thrive on profit, not ethics. While consumers and investors may feel better about backing “responsible” companies, the systemic issues of inequality, climate change, and corporate exploitation are unlikely to be solved through the stock market. True progress requires policy reform, not feel-good investing trends.

Ethical investing is more of a branding exercise than a revolution. Its appeal may continue for now, but its long-term effectiveness remains questionable. Until ethical investing moves beyond superficial metrics and prioritizes systemic change, it risks being just another financial fad – one that distracts from real solutions.

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