Economy and Society: SEC review finds potentially misleading ESG fund practices

ESG developments this week

In Washington, D.C.

SEC investment fund review reveals potentially misleading ESG practices

On April 9, the Securities and Exchange Commission announced that its recently enhanced examinations of the investment community’s use of and adherence to ESG investment principles has yielded results. The Commission set out to find whether investment companies were keeping the promises they were making to investors. And it learned that, in some cases, according to an article in the Wall Street Journal, they aren’t:

“The Securities and Exchange Commission said Friday it has found some investment firms that tout socially responsible investing were potentially misleading investors, part of the agency’s enhanced review of funds that claim to support environmentally friendly policies but don’t adhere to them.

These funds broadly market themselves as trying to invest in companies that pursue strategies addressing environmental, social or governance issues from climate change to corporate diversity.

The SEC didn’t disclose the names of firms or how many were involved in the review.

The regulator found instances in which investment firms were making potentially misleading statements about their ESG investment processes as well as their adherence to global ESG frameworks. It has also seen cases where portfolio managers weren’t consistently disclosing their ESG strategies and where their proxy voting on shareholder proposals didn’t align with advisers’ stated stance on socially responsible issues.

Several firms didn’t have proper policies and procedures in place to address ESG or reasonably prevent violations on such matters, the SEC said, finding controls inadequate to ensure clients’ ESG-related investing preferences were reflected. Some firms also lacked compliance programs that could reasonably guard against inaccurate ESG-related disclosures and marketing materials, the agency said.”

On Wall Street and in the private sector

BlackRock ESG ETF launch biggest ever

On April 8, BlackRock launched a new ESG ETF (exchange-traded fund) that became the biggest fund launch in the 30-year history of the ETF business, securing more than $1 billion in its first day of trading: 

“Investors poured about $1.25 billion into the BlackRock U.S. Carbon Transition Readiness ETF (ticker LCTU) on Thursday, making it the biggest launch in the ETF industry’s three-decade history, according to data compiled by Bloomberg….

LCTU’s eye-catching debut comes amid a broad boom for ETFs focused on investments that meet environmental, social and governance standards. They attracted a record $31 billion in 2020, almost four times the prior year. About $6.3 billion was added in January, also the most ever, as investors bet the Democrats clean sweep of the U.S. government would usher in a swath of green policies.

That’s all taken ESG ETF assets to a record $74.8 billion, up from less than $10 billion two years ago. The largest ETF in the space is also from BlackRock. The iShares ESG Aware MSCI USA ETF, with $16.3 billion of assets, is trading at an all-time high after returning more than 50% in the past 12 months.”

BlackRock joins ESG credit-line trend

Last week, BlackRock also became the latest large, high-profile corporation to sign on to an ESG-directed credit facility. According to the Wall Street Journal, the new credit deal was disclosed in a regulatory filing made public last week and was signed on March 31:

“The firm struck a financing deal with a group of banks that links its lending costs for a $4.4 billion credit facility to its ability to achieve certain goals, like meeting targets for women in senior leadership and Black and Latino employees in its workforce.

The firm plans to boost the share of Black and Latino people in its U.S. workforce 30% by 2024, a spokesman said. It aims to increase the share of women in its senior leadership ranks by 3% each year.

BlackRock’s progress on growing assets in funds focused on companies with high environmental, social and governance ratings will also impact its lending costs. The firm aims to grow the roughly $200 billion it manages in so-called sustainable strategies to $1 trillion by 2030….

BlackRock is best known for its sprawling lineup of funds that trade rapidly and track indexes. The firm and its CEO, Larry Fink, have pushed companies its funds invest in to be more attentive to environmental and social risks—and to increase workforce diversity….

Going forward, the new lending facility will impose a cost on the asset manager for missing its workplace-improvement and other goals.”

Europe’s biggest oil producer goes green

In an interview conducted by Bloomberg on April 9, Norwegian Finance Minister Jan Tore Sanner described his country’sand, by extension, its massive sovereign wealth fund’s intention to invest heavily in sustainability-related investment vehicles. “We must have the highest possible return on our money,” Sanner told the financial news organization, “but we also want to know that it is invested in a responsible way.” Bloomberg continued:

“The goal is “to increase the competence related to climate risk, investment opportunities, the consequences associated with the transition to the low-emission society,” Sanner said. “This is because this will be perhaps the most important framework condition for large investors in the next 10-20 years.”

Western Europe’s biggest oil nation is now trying to use its giant wealth fund to steer the planet toward a greener future. Its chief executive, Nicolai Tangen, has said he will use his clout to try to force companies to act more responsibly.

Under Sanner’s proposal, which still needs parliamentary approval, about 25-30% of portfolio companies will be cut. Though that sounds like a lot, it only represents about 2% of the fund’s total market value. Sanner says he wants to avoid investments in new emerging markets because they tend to have “weaker institutions, weaker protection of minority shareholders, less openness.”

The changes will make it easier to manage the vast portfolio, and reduce complexity and risk, Sanner said.

The fund, which returned 10.9%, or $123 billion, on its total investments last year, has followed strict ethical guidelines, including bans on certain weapons, tobacco and most exposure to coal, since 2004.”

Oil and gas stocks continue to heat up

In a April 9 piece, noted the perceived incongruence of the ESG push in the markets and the concomitant fossil fuel-stock rebound:

“In the year to date, the energy sector on the S&P 500 has gained 29.4 percent, Palash Ghosh reported for Forbes. This makes energy the best-performing sector on the S&P 500, followed by finance as a distant second, with a gain of 17.6 percent.

The rally in oil stocks came on the back of improving oil prices, and oil prices improved on the back of, mostly, hopes that economies will soon begin returning to normal. Mass vaccinations in key oil markets did a lot to fuel this post-pandemic optimism about oil, pushing benchmarks above $60 a barrel and drawing investors to oil stocks.

Vaccines were, of course, not the only factor. OPEC+ also kept its production limited for longer than it had initially planned. The cartel decided at its last meeting to raise production gradually and the fact that this decision did not send prices plunging shows that expectations of a demand rebound are really strong right now….

All this is happening as pressure continues to mount on oil and gas companies to basically stop being oil and gas companies. What the surge in oil stocks is demonstrating, however, is that a lot of investors still prefer returns to clean energy promises. One early proof of this was BP’s share price drop after CEO Bernard Looney last year announced perhaps the most ambitious energy transition plan among Big Oil majors….

ESG investing may be all the rage these days, and solar stocks may be favorites among the ESG crowd, but oil hasn’t fallen out of grace yet.”

In the spotlight

Is ESG necessary? Research examines how climate risks are priced into markets 

In an article published April 9, Institutional Investor magazine reported on a new study conducted by Dimensional Fund Advisors that purports to show that the “E” portion of ESG is unnecessary and that marketsbeing in their view efficienthave already priced climate and transition risks into asset prices, across various investment-vehicle types:

“Although evidence is accumulating about the effect of climate change on everything from weather patterns to human health, scientists can still only paint a partial picture of the future. Nonetheless, stock, corporate and municipal bond, futures, and options markets are doing a good job of incorporating climate risks into asset prices, despite the complexity and uncertainty.

In recent research, which includes a review of outside academic studies, Dimensional Fund Advisors sought to address the question of whether and how well climate risks are priced into different markets. Dimensional looked at how the markets priced both physical risks and transitional risk, which arises as economies move away from fossil fuels and to a low carbon economy….

“Many of the effects are hard to predict, hard to quantify, hard to bring to the present in terms of value or cost,” Savina Rizova, the firm’s global head of research, told Institutional Investor. “First, financial markets do pay attention to these risks, despite the complexity and even the longer run effects of climate change. Second, companies have incentives provided by competitive financial markets to better manage their exposure to climate risks if they want to have a lower cost of capital.”…

Investors interested in owning securities that don’t contribute to climate risk may not need to own funds with an ESG label.”

Notable quotes

“Based on the Fama and French analysis this implies that if investors have a preference for highly rated ESG stocks then those stocks will offer lower average excess returns. Note that this conclusion is contrary to the views of many ESG advocates in the investment profession. For instance, Blackrock CEO Larry Fink (2020) states that, “Our investment conviction is that sustainability and climate integrated portfolios can provide better risk-adjusted returns to investors.” We find little support for this conviction in either the theory or empirical evidence. On the other hand, there is some good news for high ESG companies in that those lower expected returns mean lower discount rates and lower discount rate produce greater valuations.”

Bradford Cornell and Aswath Damodaran, “Valuing ESG: Doing Good or Sounding Good?” March 20, 2020.