ESG (Environmental, Social, and Governance) investing has exploded, but excluding "sin stocks" (oil, tobacco, weapons) changes the mathematical profile of an index.
Tracking Error
When you exclude 10% of the market capitalization of an index for ESG reasons, your fund will no longer track the market return. This is called tracking error. If oil stocks surge (as they did in 2022), ESG funds will vastly underperform standard global trackers.
Conversely, if tech stocks surge, ESG funds often overperform, as they are naturally overweight in technology compared to the broader market.
The Cost Premium
ESG funds typically charge a premium. A standard global tracker might cost 0.15%, while its ESG equivalent costs 0.25%. Over 30 years, that 0.10% difference compounds significantly. You must decide if the ethical screen is worth the mathematical cost.