By Gale A. Kirking, CFA
In my introductory essay to this series, I wrote that the single most important reason why responsible investing can be so difficult is that the financial services industry is not at all set up to facilitate truly responsible investment for individuals. That probably sounds like strong condemnation, and I suppose it is, but I intend this observation to be realistic, helpful, and potentially even constructive.
I will expand upon that here while illustrating especially how individual investors might deal with this situation.
Ted and Mary meet their adviser
Let’s start with a hypothetical but very realistic example. Ted and Mary Smith are a late middle-aged couple. They have worked hard and life has been good to them, too. They can be classified as high net worth investors. Funding their retirement is not really a major issue, but they want to invest their liquid assets for high returns so that they can pass on money to their children and grandchildren while also generating a tidy sum they can leave to various charities when they’re gone. They care about the environment and especially about the less fortunate members of the global human community. They are concerned about climate change, shrinking biodiversity, habitat degradation, growing disparities in income and wealth, hunger, and fostering social and workplace environments of diversity, equity and inclusion. The Smiths are depending upon their financial adviser, John, to help them accordingly to manage their investments. They’ve told him that, ideally, all their money should go into “responsible” and “sustainable” investments. They’d also like to earn excellent returns, of course.
“Okay,” John inquires, “so what do you regard as responsible?” He needs to ask, because each client might have a different answer to that question.
“Well, I dunno,” Ted begins, “what do you think? What are the possibilities?” Then Mary jumps into the conversation and she begins to explain their concerns about the environment and various social and political issues. Mary also says that of course they want to earn returns that beat the market. Ted counters that, yes, well, good returns are important but beating the market isn’t the most important thing. Mary frowns a little bit just then.
John is in a challenging and yet enviable position. On the one hand, he stands to make a lot of money in commissions and fees in the months and years ahead from managing the Smiths’ investments. On the other hand, he’s already thinking that to satisfy Ted and Mary could be a rather daunting undertaking.
Fiduciary duty is on John’s mind
The investment firm for which John works has been around a long time. It has a good track record of earning high returns for investors. In addition to high net worth individuals and families, the firm also has a number of major institutional clients, including the pension funds for several local manufacturing companies. “Fiduciary duty” is a term John has heard the firm’s founding partners use over and over again.
In the U.S., a financial adviser like John has to satisfy specific fiduciary responsibilities when managing certain retirement plans. In particular, such an adviser must act solely in the interests of a plan’s beneficiaries; must invest with the care, skill, and diligence of a prudent person familiar with such matters; and must well diversify investments in order to avoid large losses. Now, the Smiths are not a regulated retirement plan, so the definition of fiduciary duty in their case can be a little more flexible, but John is a fiduciary nonetheless. He also is well aware that the whole area of ESG has been a source of controversy in the firm and that some high net worth clients have gotten pretty bent out of shape sometimes when their investments underperformed the benchmarks. The firm’s compliance officer has said, in fact, that, in his opinion, selecting stocks on the basis of ESG criteria is not even consistent with fiduciary duty, and he is not alone within the investment industry in holding that view.
John’s default standpoint is that the Smiths need to be invested in a broadly diversified stock portfolio. (He will advise them to buy some bonds, too, but, for the sake of simplicity, let’s just consider the stock portfolio here.) After hearing the Smith’s explanations and completing a mandatory investment questionnaire to gather more information about Ted and Mary’s net worth, investment experience, and risk tolerance, John suggests that the couple consider investing half their funds in an S&P 500 Index Fund and divide the remaining half among several actively or passively managed ESG funds. That way, the adviser points out, half of their money will be securely invested in the strong and resilient U.S. economy and the other half can be devoted to the responsibility issues they deeply care about.
John gives the Smiths several thick prospectuses and other mandatory disclosures for the funds they are to consider. Ted and Mary agree to review the materials and to meet again in a week.
Portfolios chock full of objections and surprises
A week has passed and the Smiths are back in their investment adviser’s office. They are confused, full of questions, and not very happy. They have thoroughly reviewed all the materials they had been given the prior week.
They speak first about the S&P 500 Index fund. It includes dozens of companies that they don’t want to invest in. More concerning to them, however, is that upon review of the materials for the ESG funds they found quite a lot of the same companies in those portfolios. One of the so-called “responsible” funds even invests in Philip Morris, the tobacco company manufacturing and selling Marlboro cigarettes as well as numerous other brands of smoking, smokeless, and vaping products. “What,” Mary would like to know, “is socially responsible about that?”
John is now a little nervous as he Googles “Is Philip Morris a socially responsible company?” He quickly finds that CSRHUB, the aggregator of ESG data and ratings, assigns the tobacco company a “High” score of 94 points out of 100 based upon 63 data sources. He also finds that Sustainanalytics gives the Marlboro Man’s creator a “Medium Risk” sustainability score of 27.3 and notices a recent news story headlined “Philip Morris seeks to become ESG company.” (Author’s note: By the way, all of this is actual information as of May 2025.)
That’s too bad, because John was hoping the fund in question would be a good choice were Ted and Mary to say they would not invest in the S&P 500. This is a fund that aims to exclude the most objectionable companies from the S&P 500 while including all the others and adding in some mid-cap stocks with good ESG ratings to broaden out the market exposure. “Cross that one off the list,” John thinks to himself.
Next, they discuss a sustainable strategy mutual fund that has a folksy name and is run by an investment company that is a Certified B Corp. Surely, the Smiths had thought initially, this must be just what they’re looking for. The portfolio includes the stocks of some companies they recognize by name and that seem pretty responsible, as well as a few they are not crazy about but could live with. Upon closer examination, they find one company in the portfolio that is involved in fracking, another in uranium mining, and still another that is a major defense industry contractor (although it does not actually appear to produce weapons systems). They read in the management firm’s investment strategy documents that it follows a “best-in-class” investment process. They ask John to explain what that means, “best-in-class,” but he answers in vague generalities revealing that he really doesn’t know.
(Also termed “positive screening,” best-in-class is a selection process whereby all publicly traded companies within a given sector or industry are scored according to a defined set of ESG criteria. The companies are then ranked from best to worst among their peers. The best-ranked companies are then considered as possible investments. So, for example, the best (i.e., most responsible) fracking company and the best cigarette maker may make it into the portfolio, but not all the other fracking companies and cigarette makers.)
Mary now suggests that, with John’s help, they should look at picking their own stocks to build an individualized portfolio. How many stocks would they need?
Well, John explains, studies have shown that such a portfolio should include at least 20 to 30 stocks. Forty or 50 might be better, but it’s a lot of work to do that much research and to monitor and manage such a portfolio.
John is starting to feel a little desperate now. He suggests that the Smiths look at the S&P 500’s official sectors before their next meeting to see which ones they like and do not like. He prints out a list for them. It includes 11 categories: Information Technology, Financials, Health Care, Consumer Discretionary, Communication Services, Industrials, Consumer Staples, Energy, Utilities, Real Estate, and Materials. This is a broad breakdown. In fact, it’s not going to be very helpful to the Smiths. If they later search the internet, Ted and Mary may find that each of the 11 sectors is broken down into between 2 and 14 different subsectors or industries. These also are very broad and probably will not provide useful guidance for finding responsible companies.
Before their meeting ends, John also gives the Smiths a couple more prospectuses for investment funds that are built upon broad-based ESG indices (which happen also to be managed according to best-in-class methodologies). He recommends that they reconsider whether they can compromise on their responsibility requirements.
Compromise is the usual outcome
John is perhaps a very good financial adviser, but, in the end, he is not going to be able to give the Smiths exactly what they want. There are a number of reasons for this. First of all, different do-good investors are going to have diverse priorities. Any collective investment product, such as a mutual fund or exchange-traded fund (ETF) designed for an average responsible investor will not satisfy everybody. It also can be very difficult for the client and adviser to completely understand each other. They are likely to talk past one another, because each is coming into the discussion with his or her own somewhat narrow perspective.
The idea of collaborating to put together a portfolio of individual stocks is a nice idea, but John is probably not going to be very helpful. First and foremost, he is not a stock picker. Second, he cannot possibly charge enough in fees to build and manage a carefully constructed portfolio of individual securities. In addition to providing investment advice, good financial advisers are trained in taxation, estate planning, insurance, and other areas. Usually, they are going to sell packaged securities, like mutual funds and variable annuities. Analyzing individual companies and their securities is specialized and time-consuming work and not the adviser’s specialty.
Moreover, a financial adviser will be concerned about the question of fiduciary duty. A reasonable portfolio of packaged securities will always be diversified and generally moving up or down with the broader markets. Part of an adviser’s work is to keep clients from overreacting when markets fall or soar. It’s easier to do that when the clients are invested in mutual funds.
Some of those packaged securities, moreover, will be designed for sale not only to individual investors but also will be oriented toward institutional investors, like pension funds. A pension fund that wants to claim concern for sustainability but while remaining mindful of its fiduciary responsibilities may not be too fussy about all the ethical details.
ESG factors as risk measures and profitability predictors
Fiduciary obligations have had a major influence on how the investment industry thinks about ESG, and, in my view, this creates problems. In order to justify collecting and evaluating data concerning individual companies’ environmental, social, and governance characteristics and including it into investment decision-making, the industry has tried to show that these factors affect the riskiness, opportunities, and profitability of individual companies and, consequently, the investment returns from investing in those companies. Numerous academic and industry studies have set out to prove connections between ESG risk and opportunities and investment returns. These studies have had mixed results in their determinations and, in my view, sometimes their findings and claims are pretty tenuous.
The question as understood by an investment professional is, Can I generate alpha by considering ESG factors. Without getting into a discussion of investment theory, I will state simply that alpha refers to investment return that exceeds the return of the relevant benchmark at a given level of risk. It denotes outperformance. So, for example, if I pick stocks on average better than those in the benchmark I have set for myself, such as the S&P 500, and if I thereby produce higher returns than does that benchmark, then I have generated alpha.
Producing alpha is hard. Generating alpha consistently over the long term is perhaps not even possible. When somebody achieves this, that person or organization probably is a statistical anomaly, an outlier. So, does ESG investing consistently produce alpha? In my opinion, no, it does not. Also in my view, achieving alpha should not even be a responsible investor’s stated or mandated objective.
In a future essay in this series, I will explain that in managing investments I personally aim to achieve what I call superior socially responsible, risk-adjusted return through a thematic investment approach. For me, as a responsible investment purist, that is more important than alpha.
But coming back to the question of ESG factors and risk and return, some of the arguments that can be made in this area are pretty questionable. For example, let’s say the management of a company (in whatever industry, it doesn’t much matter) regularly squeezes its employees and its suppliers for all their worth. It doesn’t allow unions, works its people half to death, habitually pays its suppliers late, lays off employees just before they qualify for retirement benefits, and designs its aesthetically appealing products to wear out just as soon as their warranties expire. Maybe it’s been doing all these things for years and getting away with it. That appalling behavior reflects several ESG risks, but does it make the company less profitable? Well, maybe not.
Consider another company. It really should modernize its pollution control technology, but doing so would be expensive. So far, the company is polluting right around the maximum legal limit, occasionally slipping over it. It’s got good lawyers and is well connected with local politicians. The company has publicly committed to achieve greenhouse gas neutrality by 2050, but, come on, that’s a long way off. Again, there are several ESG risks in play here. Responsible investors should not buy this company’s stock, but they might earn higher returns if they did because, in this company’s case and from its management’s perspective, these ESG risks may not be risks at all. Bad corporate behavior is not always a risk. Sometimes it’s an opportunity.
So, would seriously mitigating these so-called ESG risks benefit these companies and boost the returns to their shareholders? Are reduced financial risk, increased business opportunities, and greater profitability of individual companies positively related to improved ESG performance? Some sustainability theorists would say yes. Unfortunately, that very simply is not always the case.
ESG as marketing gimmickry
Finally, in discussing the business of ESG, sustainable, or responsible investing, it should be noted that this has in fact become an industry of its own. The Investment Company Institute, a trade organization based in Washington, DC, reports that as of March 2025 it counted 829 mutual funds and ETFs investing according to ESG criteria, including 395 with broad ESG focus, 121 with environmental focus, 202 with religious values focus, and 111 with other focus. In some cases, these collective investment vehicles had not started out as ESG products at all, but, as ESG became popular in recent years, they were rebranded and retooled to be operated and marketed as sustainable.
In addition, there are dozens of investment services companies, products, and brands created in recent years that offer sustainability ratings to companies issuing securities and ratings data services to fund managers. As can be expected, the usual crowd of consultants, Big Four audit firms, marketing experts, lawyers, and professional certifications also have moved into the field.
One might like to think and hope that all this interest and activity will bring more and better information and clarity to the sphere of ESG investing. To some extent it has, but that is not uniformly the case. The do-good investor should take in all this new information with a healthy dose of skepticism and caution. Remember, there are at least 63 sources of information out there that in combination made the Marlboro Man representative of what is put forward as one of the most responsible companies in America.
I hope you will join me again when we release my next essay in this series on responsible investing, wherein I will be providing suggestions on how the investor can decide what is really important to him or her in relation to investing. Subsequent essays, then, will go into the financial and responsibility aspects of designing a responsible portfolio and selecting individual securities for the portfolio. If you’d like to be sure not to miss future articles in the series, please consider subscribing to our Channel BlueGreen at https://bluergreener.world/blog/ and/or follow us on one of our associated social media channels (Facebook, LinkedIn). I also encourage you to share your own experiences and questions in the comments to our Channel BlueGreen https://bluergreener.world/blog/ or at one of our associated social media channels (Facebook, LinkedIn), or by following me at Substack (https://galekirking.substack.com/). Please, let’s keep our comments polite.
About the author: Gale A. Kirking is a Chartered Financial Analyst (CFA) and has earned the CFA Institute’s Certificate in ESG Investing. He formerly was employed as a senior equities analyst and director of investment research and has worked in and around the financial services sector for about 30 years. Kirking is not a licensed or registered financial adviser in any jurisdiction and does not make his living by providing financial advice. This essay and series are not intended to provide specific investment advice targeted or tailored to the needs of any individual investor. The views expressed herein are the opinions of the author. Other equally or more knowledgeable people will have different views.