ESG Developments This Week
In Washington, D.C.
Democrats push back against the ESG pushback
In response to House Republicans’ plans to use their new majority to investigate the ESG movement, three Democratic senators penned an op-ed accusing their GOP colleagues of overstepping. The three senators—Sheldon Whitehouse (D-R.I.), Brian Schatz (D-Hawaii), and Martin Heinrich (D-N.M.)—also accused Republicans who oppose ESG of being anti-capitalist:
There is a cohort of elected officials in the United States presently engaged in an anti-capitalist crusade against free-market principles. No, they are not socialists. They are congressional Republicans, and they are attempting to prevent financial institutions from allocating capital in accordance with investor preferences and risk management principles. This attempted crackdown is purely ideological in nature — it is an exercise in political pressure to force a gross government overreach into U.S. capital markets.
This campaign, which should offend anyone with even a modicum of pro-market sensibilities, is being championed from within the Republican Party. Republican state lawmakers and members of Congress are attempting to stifle the growth of sustainable investing and to punish corporate efforts at climate-related financial risk management….
Elected officials should ensure that financial regulatory agencies properly account for risks in their financial stability and supervisory work. Climate change poses unambiguous risks to the financial system, and regulated financial institutions do not have the luxury of picking which risks to manage and which risks to ignore.
But Republicans are engaged in an entirely different pursuit. They are attempting to bully financial institutions and regulators into ignoring market demand and market risk. Imagine elected officials telling investment firms they cannot offer large-cap or small-cap funds, or emerging market funds, or value funds — or, for that matter, sector funds with exposure to energy companies.
That would be considered preposterous. It is similarly bizarre to tell asset managers they are not allowed to reflect the preferences of their investors in their investment stewardship and proxy voting, or to tell regulators that they are not allowed to consider a major source of economic and financial risk.
This isn’t how the free market works. This is picking winners and losers, in this case putting a thumb on the scale in favor of the fossil fuel industry and completely disregarding the overwhelming risks that climate change poses to our economy and financial system.
In the states
Virginia governor expresses concerns about ESG investing
Most government activity supporting or opposing ESG investing has taken place in states with Republican or Democratic trifectas.
Virginia has a divided government with a Republican governor and House of Delegates and a Democratic state Senate. Gov. Glen Youngkin (R)—who worked for most of his career in financial services (private equity), where he eventually became co-CEO of the Carlyle Group— signaled last week that he, like many of his Republican colleagues, has some concerns about ESG:
Virginia Governor Glenn Youngkin, who ran one of the nation’s biggest investment firms before he took office, said ESG investing is under fire because it has morphed from a philosophy for picking stocks into a weapon for penalizing companies that don’t make the cut.
“Is having world-class transparency and governance a good thing? Yes, it’s a really good thing,” Youngkin, a Republican and the former co-head of Carlyle Group Inc., said during a Bloomberg News editorial board meeting on Monday. But the definition of what’s good for the environment, social goals and governance isn’t one-size-fits all, he added.
ESG “means different things to different people. It just does,” Youngkin said. Amid this swirl of criteria, he continued, investment firms are telling companies, “If you don’t do X, then we’re going to penalize you, as opposed to just not invest with you.”
At the end of the day, the economics of returns should justify the investment decisions, Youngkin said.
On Wall Street and in the private sector
Disney’s past political involvement could create future difficulties, according to New York Post columnist
On January 14, New York Post business columnist Charles Gasparino wrote a piece arguing that Disney’s history of what he describes as political activism has created problems that will follow the company’s old and new CEO Bob Iger going forward:
Investor appetite for woke corporatism has its limits and it usually begins with a declining share price. For further proof, look at what’s going down at Disney.
For years the “House of Mouse” was the epicenter of political correctness. Investors largely ignored this circus (including a same-sex kissing scene in children’s programming) because Disney’s stock soared.
No longer. After longtime CEO Bob Iger retired in 2020, successor Bob Chapek proved to be far less adept as a manager and a seller of wokeness. Pandemic theme-park closures didn’t help. Plus he was also crushed by Florida Gov. Ron DeSantis for opposing a law that prevented schools from teaching sex ed to 6-year-olds and lost Disney’s special tax status.
Much of his programming turned out to be a dud and his streaming strategy floundered. Disney’s stock collapsed so much that Chapek was shown the door just about two years into the job.
Iger, 71, made his return to right the ship and got more grief….
A duo of nettlesome activist investors are now circling the company like vultures. Dan Loeb’s Third Point and Nelson Peltz’s Trian Partners are unlike passive fund managers in that they use their ownership positions to advocate for changes they believe will lead immediately to a higher share price, current management be damned.
Both have big stakes in Disney and, for starters, both want Iger to focus less on programming that appeals to AOC and more on stuff that appeals to Middle America,. They want a coherent streaming strategy, cost cuts and much more.
ESG inflows continue in Europe
In contrast to American investors who pulled money out of ESG funds on net last year amid generally below-average returns, European investors are still buying shares in ESG funds, according to the numbers:
Exchange traded funds aligned with environmental, social and governance outcomes accounted for 65 per cent of all net inflows into European ETFs in 2022, even as ESG strategies underperformed.
The ESG ETFs gathered €51bn over the year out of total flows to European-domiciled ETFs of €78.4bn. The overall totals were down on 2021 when investors poured €160bn into European ETFs, but ESG’s share jumped significantly from the 51 per cent recorded then.
There is now €249bn in ESG-aligned ETFs in Europe, representing 18.8 per cent of total assets.
“In principle, this speaks of a long-term structural change,” said Jose Garcia-Zarate, associate director of passive fund research at Morningstar. He noted that 2022 was not a year to be investing in ESG for those purely focused on near-term returns. Instead a more sensible tactical approach might have been to focus on fossil fuel firms or weapons manufacturers. “I guess it tells us that investors are taking the long-term view,” he said.
Morningstar data show that “sustainable” large-cap equity ETFs in Europe have underperformed their traditional large-cap equity ETF counterparts over the 12 months to the end of December, but also on a three-year and five-year annualised measure….
The increasing relative popularity of ESG strategies in Europe is particularly eye-catching given that it has also coincided with a hard year in terms of ESG’s public image, particularly in relation to accusations of greenwashing.
In 2022, asset managers downgraded scores of “dark green” Article 9 ESG funds holding tens of billions of client money to their lighter green Article 8 counterparts under the EU’s sustainability classification.
Growing concerns over greenwashing in Europe have coincided with a strengthening anti-ESG movement, particularly in the US, against “woke capitalism”….
Garcia-Zarate said Morningstar analysis of the US market at the end of October revealed that while about 20 per cent of ETF holdings in Europe were ESG-related, the comparative figure in the US was only around 1 per cent.
Vanguard’s climate aftermath
Last month, Vanguard—the second largest asset management company in the world and one of the Big Three passive asset managers—announced that it was leaving the Net Zero Asset Managers (NZAM) initiative to guarantee its investment flexibility. On January 12, Reuters published an analysis speculating why Vanguard left the initiative but the other two Big Three asset managers—BlackRock and State Street—have not:
Vanguard Group’s decision last month to quit a key climate change coalition underscores how the retail investors who dominate its client base focus less on environmental, social and corporate governance (ESG) priorities than institutional investors.
Vanguard said last month it would drop out of the Net Zero Asset Managers (NZAM) initiative, whose members commit to making their investment portfolios emission-neutral by 2050. It said 80% of its close to $8 trillion in assets are in its index funds, which primarily attract retail investors.
These funds generally do not have discretion to include or exclude stocks beyond a pre-set mandate, and most do not account for carbon emissions.
Vanguard did not explain what changed since 2021, when it joined NZAM, but said it was responding to a desire of its clients to provide “clarity” and make its independence clear.
Vanguard’s biggest competitors, BlackRock Inc (BLK.N) and State Street Corp’s (STT.N) asset-management arm, rely more on institutional investors including pension funds and foundations. Both BlackRock and State Street have stuck with NZAM.
At BlackRock and State Street, mutual funds and exchange-traded funds – the investment vehicles popular with retail investors that include many types of index funds – account for around 41% and 30% of assets, respectively, according to data from Morningstar Direct and company disclosures. At Vanguard, that figure is 88%….
Vanguard’s NZAM participation was modest to begin with. It said 4% of its assets would be aligned by 2030 with a goal of net-zero emissions, compared with State Street committing 14% of its assets. BlackRock has said it expects more than half its assets to meet the 2030 target, but it has not made a firm commitment.
“You wonder why Vanguard signed up in the first place,” said Hortense Bioy, global director of sustainability research at fund ratings firm Morningstar Inc (MORN.O).
Vanguard representatives said the company looks forward to continuing constructive conversations with policymakers….
Vanguard’s exit from NZAM has not fully spared it from the ESG backlash. A coalition of 13 Republican state attorneys general are pressing on with a motion asking federal energy regulators to limit Vanguard’s ability to invest in public utilities.