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Watch out for equity gambles in the guise of ESG investment

Last year, the UK’s Financial Conduct Authority issued a warning about investment apps: The “game-like elements” some of them have— badges, points, leader boards, fun post-trade messages—might contribute to “problematic, even gambling-like, investor behaviour.” There’s new legislation on its way, it said, so firms relying on gamification to get trading going might want to review what they did.

That’s an implicit threat from the FCA, so I imagine there is conversation underway about what level of gamification is a good thing (it engages a new audience) and what is bad (it makes users borrow money and use it stupidly). But if the regulator is worried about an epidemic of stock gambling, I wonder if it’s looking in the right place. The UK’s young, after all, seem remarkably sensible with investments: They mostly have auto-enrolment pensions and seem attracted to low-cost index funds.

Vanguard notes that 74% of UK clients signed up last year were under 45 and 41% were under 30. Vanguard products are fine, but offers no dopamine hits. Hargreaves Lansdown, the UK’s best-known investing platform (with no in-app points) has also reported a rise since the pandemic in younger investors opening accounts. Its users aren’t looking to top trader boards.

So who should the FCA be looking at? Let me suggest professional fund managers. Look at what they’ve been up to. These are the people who should know that valuations matter—it’s the price you pay for an asset that determines your return. They know that diversification matters too. They also know that fast-rising supply of money leads to inflation (albeit with Milton Friedman’s ‘long and variable’ lag), that inflation means rising interest rates, and that highly valued stocks struggle as rates rise.

Yet what did many of these experts do in 2021? They piled in to pricey American tech stocks and went mad for environmental, social and corporate governance (ESG) goals, the latter of which not only limited their investment universes but came with no long-term evidence that it might be a good idea. Gambling for a short-term dopamine hit? Who’s guilty now?

This brings me to an irritating public offering: the Hypatia Women CEO ETF from Hypatia Invests, a company that provides “indices with a gender-lens”, such as its Hypatia Women CEO Index and Women Hedge Fund Index. The ETF, as the name suggests, is to track the former—or the 115 listed companies in the US that have market capitalizations of more than $500 million and are run by a woman.

The firm says you should invest for three reasons: to diversify, to “invest your values” and to “create impact.” That’s nice. Who wouldn’t want all those things? In my experience, though, most investors want something else too: returns. Might they get them? The ad says ‘yes’. It notes that the index did brilliantly in 2022, significantly outperforming the FT Wiltshire Small Cap Index. It has also outperformed that index by 3.04 percentage points since 2017. But look closer, and you will notice that the two indices tracked each other until late 2020. The outperformance is only obvious for two years and might have something to do with small cap outperformance or perhaps the fact that the best-performing stock in the S&P 500 over the last year (Occidental Petroleum, up around 118% in 2022) is run by a woman. It might be up because it is run by a woman or because it is an oil and gas company. Who can know? But the fact that this is not clear means it’s hard to argue that companies run by female CEOs outperform over the long-term.

It feels like maybe they should—not necessarily because women think or behave differently, but because, as an old report from McKinsey suggests, getting to the top has been insanely hard for the generation of women now of an age to be there. Chances are good that the few who have made it are especially brave, brilliant and resilient. Yet, even though this sounds good, just as with ESG, we have no data to truly know.

There haven’t been enough female CEOs, in enough different market conditions, for a long enough period of time, for the numbers we have to tell us much of anything. It isn’t easy for men to become CEOs either. There is a little more evidence that a lot of female leaders or a generally diverse group of executives in a firm helps performance, and that female-led companies have more gender diversity at higher levels. Some investment products pander to this idea, but again, there isn’t quite enough to be sure.

Letting appealing but unproven ideas form a portfolio is a gamble. It limits your investment universe and ignores valuations. This may have been okay for the great bubble that began to deflate in 2022. In 2023, it’s silly. In today’s times, why would investors use an unproven metric (CEO gender) over one known to work (valuation plus diversification)? 

Merryn Somerset Webb is a senior columnist for Bloomberg Opinion covering personal finance and investment. ©bloomberg

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