In February 2023, former Vice President Mike Pence (R) took to X, formerly known as Twitter, to voice his opinion on ESG investing—a type of investing that focuses on environmental, social, and governance factors.
“Disappointing that President Biden is putting ESG and woke policies above hard-working Americans’ retirement accounts! We will keep fighting until we put a stop to ESG once and for all!”
For Pence, a sexagenarian Republican with traditionally conservative values, whose time in the House primarily centered on Foreign Affairs, Agriculture, and Judicial Affairs, the outlash seemed rather random.
Former Vice President Pence’s comment underscores a common misconception about ESG. The aim of ESG investing is to increase overall corporate responsibility as investors seek to align their portfolios in more socially and environmentally conscious ways. But the term has been branded as a partisan tool. Many Republicans view ESG as an artifice of “woke capitalism,” a phenomenon that promotes a “political agenda” while sacrificing economic gains.
The term ESG was an attempt by investors to broadly categorize sustainable investing efforts, but the global economy was already trending towards green investing before the phrase. According to Cary Krosinsky, a faculty member at Yale’s Center for Business and the Environment, “[ESG] is sort of an oversimplification, which is necessary so that something can resonate with the general public, but a lot gets lost in translation.” The bulk of ESG’s publicity problem comes from data indicating that ESG funds result in less profit than comparable funds. But the data doesn’t tell the full story.
ESG may be perceived by conservatives as a “woke” policy, but fundamentally, sustainable investing is about making smart economic decisions. If an investor cared about the environment over profit, they could invest in ESG funds. If they cared about both the environment and profit, they could invest in ESG funds. And if an investor only cared about profit, they could still invest in ESG funds. At the end of the day, regardless of the type of fund, profit can be found anywhere.
15 years ago, there was no political connotation to the phrase ESG. “ESG is kind of a uniquely investor focused term. Investors had already been considering environmental, social and governance factors as financial risks, so when they read sustainability reports, they were converting sustainability information into environmental, social, and governance risks into financial performance. They already had this terminology of ESG–it wasn’t a branding thing,” says Todd Cort, the Faculty Co-Director of the Yale Center for Business and the Environment.
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To understand how this technical term has made its way into mainstream American political discourse, it is necessary to examine investment trends of the past decade. The term was coined in 2006 by the United Nations to require companies to include ESG criteria in their data to further the process of sustainability. This followed the Kyoto Protocol, the world’s first legally binding climate treaty that took effect in 2005. Since then, ESG has grown into a mammoth industry: one measure estimates that ESG investment is globally valued at over 17.5 trillion U.S. dollars. According to Jason Eis, a partner at McKinsey & Company specializing in sustainable investing,“It’s remarkable how much things have changed in the last five years. If you take a look at the balance of investment towards sustainable versus unsustainable, there’s been a massive shift into the way people think about the future.”
The increased focus on climate change led to radical changes. In 2017, 62% of ExxonMobile’s shareholders voted for the world’s largest gas and oil company to report the effects of climate change on business. As sustainable investing became more incentivized and traditional industries such as fossil fuels faced tough times, ESG numbers skyrocketed. And as it became a large focus on Wall Street, the public began to take notice.
Conservatives honed in on the data related to ESG. Analysis from market evaluations showed that ESG funds performed worse than a broad selection of funds from across the market, which then performed worse than only politically neutral companies. Conservative critics lambasted that investors were concerned with maximal profits, not environmental impact.
However, the data that their displeasure stems from is misleading. This isn’t an issue of the analysis: ESG indices do perform worse. However, this is because ESG is a misfitting classification for sustainable investing. “There’s a whole list of these [ESG] firms that are financially outperforming. So if you actually try to financially outperform and have a smart strategy that is possible,” claims Krosinsky.
Why is this an issue? Much of the ESG index is a result of greenwashing or low-effort investing. Greenwashing occurs when investors claim they are taking environmental impact while investing in different funds. Low-effort investing occurs when the institution often does not care for returns as much as for their claims, so they do not screen their funds as well as they should to look for profit.
Greenwashing has become a prominent concern, with companies such as Volkswagen and Amazon receiving fines for exaggerating their environmental impact. This phenomenon has led to distorted ESG ratings. To combat this, the U.S. Securities and Exchange Commission (SEC) instituted a policy in October 2023 that set regulations for what can and cannot be labeled an ESG fund. According to Cort, “the purpose is to provide clarity around the the funds strategy, rather than the label.” Although not a complete solution, regulations such as these will provide a clearer view of the return of optimal ESG strategies.
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It will still take a while for ESG to leave the political spotlight, though. Cort says: “There are many barriers. [On] either side of politics, there’s money, there’s donors with interests who give money for a particular reason. They’ll primary you if you don’t follow their request.”
Fundamentally, apart from donors, the political Left and Right have split opinions on ESG. According to Cort, “You can see where some of the political Right comes in and sees an SRI (socially responsible investment) or an impact fund, and says that’s not fiduciary duty. And someone from the Left comes in seeing this ESG integrated fund where you’re just trying to maximize returns by avoiding environmental litigation liability. That’s greenwashing! But they’re both called ESG, so they can use these radically different conclusions.”
Companies are hesitant to invest in historically profitable industries, such as fossil fuels, because climate regulations are constricting them and they will inevitably dominate a smaller share of the market year after year. And strategies are aligning sustainability with profit.
Professor Tyler Wry at the University of Pennsylvania’s Wharton School of Business says, “this whole idea that ESG is somehow anti-capitalist is a cynical and inaccurate take.” ESG just recognizes the economic impact of factors such as climate change on potential companies to invest in, and chooses those companies that will likely have strong future returns in addition to current strong returns.
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Despite everything, ESG is only projected to grow more. According to a study by Deloitte, climate change is expected to be the biggest concern on investor’s minds by 2024. Just this September, California introduced significant regulations over disclosing climate-related financial risks, which will help assist future ESG investing in one of the largest markets in the U.S.
Eis thinks that the role of ESG is undergoing a fundamental shift. “We’ve seen lots of fluctuations, but we’ve seen a lot of expectation and higher growth and sustainable oriented businesses.” The U.S. Sustainable Investment Forum (SIF) estimated that around 13% of the current U.S. market of assets under management is ESG-related.
Investors seem to be bullish on this investment strategy that doesn’t have great numbers.
“Overall, when you look at the evidence of how ESG funds perform, it tends to be a little bit lower right now. But then every time they refine ESG metrics, the link between doing this type of screening on the investments and the return of the fund gets better,” says Wry. This is a problem with data, not a problem with investment. Smart investors will continue to be good at their job.
While ESG’s politicization is not ideal, experts agree that this won’t significantly impact its future.
According to Wry, “[Investors] are going to do some stuff that is socially responsible, they want to have a good image. They don’t want to be lightning rods for criticism. But fundamentally, the purpose is to maximize profits.”
They won’t listen to the Right and abandon an area of profit because of misconceptions, but they also won’t listen to the Left and create more social change for less profit. ESG is truly capitalistic.