ESG Funds, investing platforms which are supposed to only invest in companies which work to benefit Environmental, Social, and Governance factors, have grown in popularity on Wall Street. The establishment’s theory behind their rise is that as governments become more focused on socially responsible governance, that will translate into benefits for companies which comport with those structures more effectively, and those who invest in such companies will stand to profit.

However analysts of late have been surprised to find just what stocks these ESG funds have drawn into their portfolios in an effort to acquire profits in these times.

An analysis by Bank of America recently found that of ESG funds in Europe, 6% now have investments in oil supermajor Shell. A year ago, none of the funds holding Shell was invested in the company.

Bank of America’s ESG strategist Menka Bajaj noted, “We believe [some] ESG funds are revisiting the cost of exclusion [of energy companies] given their underperformance in the first half of 2022 or waiting for regulations to be finalized amid greenwashing fears.”

The real problem is ESG concerns may flourish during bull markets when resources are so plentiful governments can chose to support less efficient companies in an effort to benefit the environment. But as the markets shift and economic activity contracts, businesses need to emphasize efficiency and profit to stay alive, and that means at times ignoring ESG factors.

So as we head into a potential economic slowdown, ESG funds are hedging against the risks of ESG equities by purchasing select qualities of highly non-ESG stocks.

Those who fail to do so can suffer quite a penalty.

BlackRock Inc, a vital proponent of the ESG ethos, was recently revealed to have lost its investors $1.7 trillion in just the last six months, according to an analysis by Bloomberg.

BlackRock had scored companies based on their commitments to certain environmental and social aims and causes, such as racial and gender diversity. On its website, the company noted, “Environmental, social and governance (ESG) investing is about investing in progress and recognizing that companies solving the world’s biggest challenges can be best positioned to grow.” 

However more recently, Larry Fink, founder of the fund and CEO, was forced to note of the period in which his fund hemorrhaged $1.7 trillion, “2022 ranks as the worst start in 50 years for both stocks and bonds.”

Meanwhile the fund has negatively impacted the profitability of one of the energy companies whose profits would help it return profits to investors. At Exxon, BlackRock used its leverage as an activist investor to vote in three activist board members, who then went on to force the company to significantly pull back on oil production over the next five years. That decrease in production means Exxon will be less able to benefit from the rising prices of oil going forward.

Meanwhile other energy companies are thriving. The Energy Select Sector SPDR Fund (XLE) is up 24% year to date.

Piper Sandler analyst Ryan Todd said of Shell, the energy company even ESG funds could not ignore, that it should have a price target of $69 to $75. Since it presently sits at $49 per share today, that would imply a potential upside of 53%.

Chevron (CVX) reported earnings of $6.3 billion for Q1, which was four times the $1.4 billion it made in the same period a year ago. Revenue was $54.4 billion for the quarter, 70% higher year over year. Its stock has climbed 22% in 2022 and now HSBC analyst Gordon Gray has set a price target of $167 — 15% above its current price.

Exxon Mobil (XOM), which even Blackrock sought to invest in, is bigger than Shell and Chevron. Its stock price is up 38% year to date. In Q1, Exxon made $5.5 billion in profit, compared to the $2.7 billion it made in the same period one year back. Bank of America analyst Doug Leggate has set a price target of $120, which would be 37% up from the current levels.

And even despite Exxon’s success over the first half of the year, Blackrock still was unable to profit.

ESG funds have their purpose. During times of vastly expanding economic activity, when societies can afford to sacrifice profits to better the environment or other causes, ESG funds could potentially be profitable. But expect that class of investment to be highly sensitive to economic conditions, and invest accordingly.