How not to let anti-ESG rhetoric reshape investment strategies

The genie is out of the bottle: The fossil fuel industry has bankrolled an effort to thwart positive environmental, social and governance (ESG) progress in the business and investment sectors in the United States. 

Although most efforts to block ESG considerations have failed across the U.S. — only 6 out of 161 anti-ESG bill proposals in 2024 have actually become law — they have influenced the investment industry more broadly. Anti-ESG efforts have sometimes persuaded otherwise thorough and thoughtful investors to publicly shy away from the in-depth analysis that an ESG lens brings to investment decision-making. In 2024, very large U.S. asset managers such as Vanguard and Blackrock appear to have drastically decreased shareholder support for environmental and social-oriented resolutions. 

A dangerously shallow approach

The U.S. anti-ESG effort promotes a shallow approach to investment with its anti-woke rhetoric, while distorting the dictionary and popular meaning and use of the word woke. ESG analysis always comes in addition to, not in place of, pecuniary investment analysis, providing a more complete picture for the pros and cons of an investment choice in a given portfolio. ESG alignment can be understood in three distinct features according to the CFA Institute: the existence of at least one process that considers ESG information with the aim of improving risk-adjusted returns; the existence of at least one policy that regulates exposure and contribution to specific systemic ESG issues while seeking risk-adjusted returns; and the existence of an explicit intent and action to support environmental and/or social conditions and a process to measure progress while pursuing risk-adjusted returns.

Understanding change and risk

Being a good investor requires more than understanding financial ratios; it also requires understanding macrotrends and underlying economic assumptions. In other words, investors and business operators must also grasp the factors that shape financial metrics, including the strong and weak signals of change. Recognizing both how external factors affect business operations (sometimes known as financial materiality or inward risk) and how business operations impact external factors (sometimes known as impact materiality or outward risk) is simply part and parcel to being a thorough investor. 

There are numerous examples of how ignoring both the inward and outward aspects of an ESG lens have led to the detriment of a company, and by extension, investors in that company. In the 1990s, Nike famously suffered reputational risks due to child labor claims in its supply chain; the public outcry led Nike to lose about 50 percent of revenue in 1998. In 2022, Disney experienced employee upheaval, disrupting business operations and productivity, when its leadership initially did not voice concerns against Florida’s ever-increasing anti-inclusion laws.

ESG investment performance is strong

The evidence is clear — factoring in ESG risks, opportunities and impacts leads to better business outcomes and better financial returns. Asset allocation based on ESG criteria is a $35 trillion industry, which equates to about 35 percent of global GDP. The largest ESG-focused exchange-traded fund (ETF), the iShares ESG Aware MSCI USA ETF, has outperformed comparable ETF benchmarks in terms of trailing returns over the past five years. In 2022, while more than $300 billion was withdrawn from all U.S. funds, ESG-aligned funds remained intact; not losing funds in a broad market withdrawal is a sign of resiliency and thus a benefit in any investment portfolio. 

Likewise, prohibiting ESG from consideration in investment portfolios results in inferior performance over any period during the past decade. A Wharton study illustrated how the state of Texas’ anti-ESG policies cost taxpayers about $500 million in higher interest payments as the policy restricted bond market competition by refusing to allow firms that consider sustainability risks and opportunities in their portfolio from competing.

It’s thus baffling that anyone or any entity — whether a household saving for retirement or a large pension fund — would be persuaded by the anti-ESG rhetoric. Who would want their investment analyst or adviser to take in less information, do less work, and in general turn a blind eye to the endogenous and exogenous factors that affect an investment portfolio? 

In other words, who is up for lazy capitalism and sleeping-at-the-job business operators and investors?

It turns out hardly anyone. 

Strong signs of investor support

Business executives and investment leaders alike have underscored that ESG alignment just makes sense and is here to stay.

A 2024 Morningstar asset owner survey for the U.S., Canada and parts of Europe and Asia indicated that 67 percent of asset owners say that ESG has become more important in the last five years; every asset owner surveyed also indicated that they are allocating at least some of their assets to ESG strategies. A 2024 survey of 1,000 wealthy retail investors in the U.S. indicated a threefold support of ESG alignment, claiming that: listed financial services businesses have a duty to take a range of climate-related actions; investments in the clean energy transition will outperform and provide short and long term returns; and climate risks are important business risks.

So how can asset owners, both individual and institutional, refrain from being duped by lazy analytics and an effort to dumb down the business of financial capital? There are at least three actions to take: 

• Choose ESG-aligned proxy voting policies (such as those offered by Vanguard’s pilot Investor Choice program), 
• Ask your money manager or adviser how ESG is incorporated in your investment portfolio 
• Inquire about specific ESG options (such as those presented by AskSustainable and AsYouSow). 

If confronted with anti-woke rhetoric, change managers.