The ESG Investing Backlash

Divesting from ESG

Over the past two decades, the financial community has largely come to accept that environmental, social and governance (ESG) factors may influence a company’s profitability and stock performance. In the past year, however, some governors have politicized ESG investing, dubbing it “woke” and banning this investment style from their state pension funds. It seems the culture wars are coming to investing.

Why the Sudden ESG Backlash?

The U.S. economy is on the path to a major transformation, powered less by fossil fuels and more by climate-friendly energy sources like wind and solar. The fossil fuel industry may publicly acknowledge the need to decrease greenhouse gas emissions to mitigate climate change, but the industry remains resistant behind the scenes. As a result, ESG investors have pushed the industry to disclose more hard data on how it will manage this transformation. This effort culminated in draft requirements for public companies to report more broadly on their greenhouse gas emissions with the Securities and Exchange Commission. Citing issues like the cost of extra reporting, the attorneys general in 21 red states wrote comments in August protesting the draft rule.

A second reason for the backlash is the success of shareholder resolutions targeting companies with poor reporting or performance on climate change and diversity. These gains galvanized opposition to ESG investors.

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If it seems as though the anti-ESG effort has suddenly sprung up in an organized manner, it’s because it has. An investigative report found that the State Financial Officers Foundation (SFOF), dark money groups, ALEC, the Heritage Foundation and others were orchestrating the bans. A dark money group called Consumers’ Research is managing the messaging and appears to be fundraising for the campaign.

ESG bans in 2021 mostly focused on fossil fuels, but have branched out to cover other “woke” corporate issues such as gun control, reimbursing travel for abortion care, diversity training and others.

Republicans aim to take ESG bans from the states to the federal arena if they win both houses in November.

State ESG Bans

Many states with Republican governors have embraced ESG investing bans in pension funds, as well as bans of major firms offering ESG investments. Some states target funds that limit or exclude investment in the fossil fuel industry, others in firearms, and some exclude any kind of ESG investment. A number of states are also targeting BlackRock (BLK), the largest global investor and a proponent of ESG investment. These states include: Texas, Florida, West Virginia, North Dakota, Oklahoma, Minnesota, Idaho, South Carolina, Louisiana, Idaho, Wyoming, Arizona, Kentucky, Utah, Indiana, Missouri, Ohio and South Dakota. Some of these states may also adopt wider ESG bans.

Texas recently enacted one of the most sweeping ESG bans. The state is removing 348 funds from state pensions, including those offered by mainstream firms like Fidelity, State Street (STT) and Vanguard. Texas has also blacklisted BlackRock, UBS Group (UBS) and eight other firms from contracting with state and local entities.

According to Republican State Senator Phil King, The ban “sends a strong message to both Washington and Wall Street that if you boycott Texas Energy, then Texas will boycott you.”

Firms like BlackRock protest that they are hardly boycotting the Texas oil and gas industry. In a statement from the company, BlackRock said it “does not boycott fossil fuels – investing over $100 billion in Texas energy companies on behalf of our clients proves that.” The firm also manages billions of dollars worth of Texas infrastructure and other bonds.

Major banks, like JPMorgan Chase (JPM), Goldman Sachs (GS) and Bank of America (BAC) were also banned from underwriting the municipal bond market. This move has driven up the cost of borrowing for municipal bonds, as there are fewer big banks competing to be underwriters. According to a study by a researcher at the Wharton School, “Texas taxpayers can expect these [anti-ESG] bills to cost them about $445 million a year in additional borrowing costs. If more banks leave, these costs will go up.”

West Virginia is also denying contracts to banks that support ESG. Five banks are prohibited from doing business in the state because of their public support for the phase-out of coal-based energy. As in Texas, this approach is likely to increase the cost of borrowing for municipal projects.

Florida also passed a similar bill to remove ESG funds from its $168-billion pension plan.

Anti-ESG Funds and ETFs

There has been a spate of new investing products tied to anti-ESG rhetoric. Most are yet to launch or have been unable to grow significantly. One exception is the Strive U.S. Energy ETF (DRLL), launched in August and already boasting nearly $316 million of assets under management. The ETF’s manager, Strive Asset Management, was founded in 2022 and backed by billionaire investors Peter Thiel and Bill Ackman to offer anti-ESG ETFs and shareholder advocacy. The firm recently filed for four additional index ETFs.

Strive Asset Management is planning to adopt the strategy of Engine No. 1 – buying companies for the purpose of authoring shareholder proposals and lobbying for shareholder votes, but from an anti-ESG perspective. While the firm may successfully grow and attract investors, it is unlikely to make a real dent in proxy voting counts given the trillions of dollars that have supported ESG proposals recently. Moreover, non-partisan proxy voting firms like ISS and Glass Lewis, which advise investors on how to vote their proxies on shareholder resolutions, have for years considered many ESG factors financially relevant.

How Will the ESG Backlash Affect Investors?

It seems unlikely that the backlash will have a big impact on Wall Street. ESG investing has lost momentum recently, but in general, the investing strategy remains extremely popular, with 85% of investors interested in ESG products.