Environmental, social and governance (ESG) investing, an investing strategy that considers factors such as carbon emissions, supply chain management and business ethics, has become increasingly widespread. According to the U.S. SIF Foundation, one fifth of the total assets under professional management in the United States in 2016 used sustainable, responsible or impact investing strategies. The ESG trend is global, with 1800 investors across 50 countries signing the UN Principles of Responsible Investment and committing to incorporating ESG issues into their investment decisions.

The growth in ESG investing is in part due to shifting market demographics and expanding ESG performance data, analytics and research. As millennials gain more prevalence in the market, the demand for ESG investing has increased. Firms have been able to meet the increased demand for ESG investments due to the enhanced availability of ESG performance data. Organizations like the CDP collect data on corporate ESG performance while MSCI ESG Research and Sustainalytics utilize this data to evaluate investments and companies across ESG criteria. According to the Governance and Accountability Institute, around 85 percent of Standard and Poor’s (S&P) 500 companies have published ESG information. This speaks to the shifting standards of corporate ESG disclosure and the increasing pool of data available to investors.

Despite ESG investing’s rising popularity, its effects on investment performance are often debated. Common methods of integrating ESG factors into investment decisions are negative screening (removing companies or sectors that fail to meet certain ESG thresholds) and positive screening (selecting the companies with strong ESG performance). Many investors worry that these restrictive methods will inhibit portfolio diversity and negatively impact returns. However, numerous studies have shown that strong ESG practices are indicative of high quality management, resource efficiency and a lower cost of capital—all which contribute to robust corporate financial performance. As a result, 80 percent of financial managers surveyed by the U.S. SIF Foundation cited financial performance as one of the main reasons for implementing ESG investing.

I contribute to the dialogue on ESG investing’s efficacy by performing a factor analysis of an ESG index (the MSCI ACWI ex Fossil Fuels Index), 21 U.S. ESG mutual funds and a traditional investment index. Financial factors are drivers of securities’ risk and returns, such as the U.S. equity market or the price of crude oil. One model to analyze a fund’s exposure to financial factors consists of analyzing the fund’s returns against the factors’ returns and examining their coefficients. I made a linear regression model using data from MSCI, the Federal Reserve Bank of St. Louis, Thomson Reuters, and the FinMason investment analytics platform from November 30, 2010 to February 28, 2018 to assess whether ESG funds have a significantly different exposure than a traditional index (the MSCI ACWI index) to a variety of factors: the U.S. equity market, the U.S. dollar, the price of gold, the price of crude oil, the Fama-French Value Factor and the Fama-French Small Cap factor, the Japanese equity market, emerging equity markets, the Chinese equity market and developed European equity markets.

The ESG funds had a range of factor exposures, highlighting that ESG investing is a broad category. For example, the ESG funds varied in their exposure to oil. Five of the 21 U.S. ESG mutual funds had a negative oil exposure. The negative exposure implies an inverse correlation between the price of oil and the ESG fund’s returns. Three of the 21 funds’ returns were not significantly correlated to the price of oil. Thirteen of the 21 funds had a positive exposure to oil and nine of these 13 had an even higher exposure than the traditional investment index.

The diversity of oil exposures can be attributed partly to differences in the funds’ ESG strategies. The two funds with the highest oil exposures were both Ariel funds (CAAPX, ARGFX). Upon examining the ESG methodologies used to construct all 21 funds, it was apparent that these Ariel funds do not incorporate environmental factors as rigorously as the other funds. According to the U.S. SIF Foundation, Ariel employs “no formal process” for evaluating the environmental impacts of companies and uses no exclusionary screens with the exceptions of weaponry and tobacco production. By using mainly positive screens, companies with low ESG scores are not necessarily excluded. In contrast, the investments with negative oil exposures combine positive and negative screening methods and largely aim to be fossil fuel free, thereby increasing exposure to best-in-class companies while eliminating companies with low environmental scores.

The stringency of the ESG methods also impacts a fund’s exposure to oil. The MSCI ACWI ex Fossil Fuels index had an overall positive exposure to oil despite excluding all the companies that own fossil fuel reserves. One possible explanation for this phenomenon is that many companies in the index, although they do not own fossil fuel reserves, are affected by the price of oil. For example, the ESG index still includes some companies involved in establishing oil pipelines, evidenced by the index’s holdings. Therefore, even if the fund is advertised as an ex fossil fuel fund, the fund’s returns may not be negatively impacted by rises in oil prices because companies may have different definitions of fossil fuel free. If oil exposure is considered an indicator of a fund’s environmental commitment, investors that are looking for an environmentally conscious fund may want to use factor analysis to assess whether the fund aligns with their values.

An ESG fund’s methodology can supplement factor analysis by helping explain to investors why a certain fund has a high or low exposure to oil. For example, the Parnassus Endeavor Fund (PARWX) had the lowest oil exposure of all 21 funds, considers far more aspects of environmental impact than the Ariel funds and excludes fossil fuel companies. Another fund offered by the same company, the Parnassus Fund (PARNX), had the third highest oil exposure and merely avoids companies associated with fossil fuels. Lastly, the Parnassus Core Equity Fund (PRBLX) did not have a significantly different exposure to oil than a traditional investment index. Parnassus’ description of the fund’s strategy does not mention any fossil fuel screening criteria. While all three funds are classified as ESG funds and are offered by the same firm, their methodologies differ in intensity, as reflected in their exposures to oil. If an investor is not able to evaluate the factor exposures of ESG funds, they should scrutinize the ESG funds’ strategies to assess whether the fund aligns with their personal beliefs and portfolio needs.

Whether ESG investing has a positive, negative or negligible impact on returns depends on the fund, as ESG funds differ widely with respect to their investment criteria. The variance in strategy and stringency impact a fund’s exposure to sources of risk and return, yielding different financial performances. As ESG investing rises in popularity, the ESG investing offerings will likely increase. When confronted with these options, investors can consult factor exposures and fund methodologies to inform ESG investment decisions that uphold personal values without compromising financial returns.

Environmentalists have long been pushing for a transition from fossil fuels to clean and renewable energies. Elon Musk, CEO of Tesla and SpaceX, has said that people are running “the dumbest experiment in history” by continuing to burn oil, coal and gas. He argues that even if we find new ways to extract oil in tar sands or in the ocean, fossil fuel must come to an end either when they have done too much damage to the earth or when their supplies inevitably run dry. Big oil companies, such as British Petroleum, Chevron and ExxonMobil, think that they have heard the message loud and clear. But have they?

With President Donald Trump in office, the United States is projected to change direction from the Obama Administration’s push for solar and wind energy to a focus on strong national oil production. A cursory search through most news outlets would paint the picture that the ancient oil magnates are not adapting to the renewable revolution and that only the exciting, technology-based companies of the future pioneer innovative energy solutions. There is a clear gap in the news that is reported. This is leaving many wondering if there are any startups that are making an impact in petrochemicals or, more importantly, if these oil magnates are doing any work to adapt to the changing energy landscape.

Even though BP, Chevron and Exxon continue to generate most of their revenue from nonrenewable sources, all three have put effort into research and investment in various forms of renewable energy. While these companies recognize the unsustainability of oil in the long-run, as an overview of their clean energy capabilities will make clear, they are not doing nearly enough to transition their own business models to account for the advent and feasibility of cleaner fuel alternatives.
In terms of renewable capabilities, BP, the world’s sixth-largest oil company, used to be one of the world’s leading solar energy companies. BP Solar, its solar subsidiary founded in 1981, had been the largest solar panel manufacturer in the world for over a decade, according to Forbes. After a 40-year run, however, BP Solar was unable to compete in the tough market and then closed in December 2011. This was accompanied by an announcement that BP would not continue to pursue ventures in solar energy.

Even with a troubled green past, BP’s renewable energy interests currently focus on biofuels and onshore wind. In 2015, BP used sugar cane to produce five million barrels of ethanol equivalent of biofuels, which seems like a sizeable amount but is, in reality, a little less than half a percent of the amount of oil it produces each year. In addition, BP holds interests in 16 onshore wind farms in the U.S., which could provide enough power for all the homes in a city the size of Dallas and save 2.7 million tons of carbon dioxide annually. With these two investments, BP has one of the largest renewable energy businesses among the oil giants. Yet, BP continues to produce more than 3.3 million barrels a day (which equates to over one trillion barrels of oil annually), and the sum of BP’s renewable efforts pale in comparison to their nonrenewable capabilities. Without a doubt the message has been heard loud and clear: “Yeah, right!”

What is more unsettling is that BP is the exception, not the rule. Chevron, the world’s ninth-largest oil company, is much more like the norm. While it has more diverse investments in renewable energy, it does not have the depth of capability that BP has established. In 2011, Chevron said it was aiming to be one of the world’s leading producers in geothermal energy, heat energy generated by and stored in the Earth. With projects in Indonesia and the Philippines, Chevron uses geothermal energy to “meet the needs of millions of people,” while saving more than 650,000 metric tons of carbon dioxide emissions annually. The company has also assisted in the development of a geothermal power plant in the Salton Sea of California, which is estimated to have a 49.9-megawatt capacity. Additionally, Chevron has money in two solar energy projects in New Mexico and California, one wind farm in Wyoming, and research interests in sugar-based biofuels. Regardless of its myriad renewable capabilities, Chevron’s carbon dioxide savings from geothermal, solar and wind energy are insignificant.

While most oil companies are at least embracing the clean energy revolution, ExxonMobil has a different outlook. ExxonMobil’s main initiative for renewable energy stems from its “Outlook for Energy” project, which studies energy demand and supply and helps ensure that “the world has access to affordable and reliable energy supplies while reducing emissions to address the risk of climate change.” The explicit exclusion of whether the energy is renewable or not is no mistake. Exxon predicts that in 2040, oil will still comprise 32 percent of the world’s energy, and that natural gas, which emits less carbon dioxide than oil, will make up 25 percent of the world’s energy. Reflecting these insights, ExxonMobil has made a big bet on natural gas with XTO Energy Inc., a natural gas company it acquired in 2010. According to Forbes, ExxonMobil produced 9.8 billion cubic feet per day of natural gas in 2016, making it the second largest natural gas producer in the world. As for other investments in renewable energy, ExxonMobil funds research in algae and cellulosic biofuels, which they hope to one day deliver due to their environmental benefits. With this sole research investment, ExxonMobil has fewer renewable energy interests than the rest of the industry.

Although BP, Chevron and ExxonMobil all have some renewable energy capabilities, it seems that their primary focus remains on oil with only minor preparations for the eventual clean energy revolution. These companies have and will continue to pale in comparison to new environmental companies that are all-in on green energy. Even with BP, which once had a large share of the solar energy market, the trend seems to be that oil companies fail at producing large amounts of renewable energy in the long-run and that their stints in cleaner forms of energy may be more for marketing purposes than for real transitions into diverse energy businesses. There is no reason to take energy out of your portfolio just yet — the oil giants still tower over the developing green energy companies. However, it seems that even with large capital reserves and expert engineers, big oil giants cannot and will not be the leading renewable energy companies of the future.