The political backlash in the United States against 'woke-ness' has levelled its aim at the financial sector, with companies and investments dragged into the culture wars.
Specifically, the consideration of environmental, social and governance (ESG) factors in investment decisions is under attack from the 'anti-ESG' movement.
As clarified by Morningstar, anti-ESG is “a proxy for opposition to the spread of ‘liberal values’ in civil society”. It has gained significant traction among Republicans, who argue that ESG investment criteria impose socio-political ideologies upon American investors.
This includes prominent Republican politicians such as former vice president Mike Pence and Florida governor Ron DeSantis, who have each spoken out against ESG, and several Republican-led states have prohibited state investment funds from doing business with asset managers that consider ESG metrics.
Yet this anti-ESG campaign makes little sense to most fund managers, who see ESG considerations as important to investor and corporate financial success, pivotal in mitigating investment risks related to climate change and human rights.
Incorporating ESG information into the broader investment process allows for a better understanding of material investment risks and opportunities than from standard valuation and financial analysis alone.
A survey by Morningstar Sustainalytics found that a large majority of asset managers incorporate ESG factors into the investment processes — to varying degrees — finding it to be financially relevant to the investment process. Individual investors and corporations have also embraced ESG, despite 70% of America’s top execs calling themselves Republicans.
Critics and anti-ESG proponents, however, say recognition of ESG factors depress investment returns, impose socio-political ideologies upon investors and force companies to adhere to a specific political stance.
The anti-ESG movement has been particularly active this year. A report by climate risk consulting firm Pleiades Strategy reveals that between January and June, at least 165 bills against ESG investment criteria were introduced in 37 US states.
Anti-ESG funds emerge
Going a step further is a new class of 'anti-ESG' funds that actively shun companies that support ESG, sustainability and causes that they see as left-leaning.
These funds, also known as non-ESG funds, use ESG data to build their portfolios "by tilting toward companies that management believes are unduly penalised by ESG ratings providers” and deliberately exclude ESG criteria from their decision-making process.
These funds come in a variety of forms. Some concentrate on 'sin stocks' — such as alcohol, tobacco, gambling and weapons manufacturers — that are usually shunned by socially responsible funds. This is the case for the AdvisorShares’ Vice ETF (VICE) which focuses on growth stocks via exposure to industry leaders in the alcohol and tobacco sectors.
Others concentrate on companies that align with conservative political ideologies. Take for example, the God Bless America ETF (YALL), that has the slogan 'Stop Investing in Woke Companies' and looks for companies with no left/liberal “political activism and social agendas at the expense of maximising shareholder returns”.
Likewise, the Point Bridge America First ETF (MAGA) invests in companies whose employees and political action committees “are highly supportive of Republican candidates”, after an initial screening based on profitability.
Undermining sustainability efforts, ethical standards and corporate transparency
The rise of such anti-ESG funds has sparked significant debate, triggering concerns over long-term sustainability, ethical considerations and lack of corporate accountability. And despite offering niche investment opportunities, critics question the funds' efficacy in a rapidly evolving financial landscape.
Detractors claim that anti-ESG funds risk sidelining the long-term viability of companies. Such funds may expose investors to industries fraught with environmental or social risks, potentially resulting in enduring financial losses.
As ESG reporting becomes increasingly commonplace, funds that neglect these criteria might struggle to hold companies accountable. The absence of such oversight raises concerns about endorsing firms that lack the initiative to improve their practices, consequently heightening investment risks.
Further, by neglecting core ESG values of climate responsibility, social justice, and ethical governance anti-ESG funds may inadvertently funnel capital towards companies with ethically questionable practices, undermining broader efforts for positive societal change.
Critics also argue that anti-ESG funds could miss out on lucrative investment opportunities in companies at the forefront of sustainable innovation. Such companies are often better positioned for future growth and are more resilient and adaptable to changing global conditions.
While they may have a place in catering to a specific investor segment, anti-ESG funds face scrutiny for their potential to undermine sustainability efforts, ethical standards, and transparency in corporate behaviour.
Failure to attract funds due to “lack of commitment”
While still early days, it’s been far from smooth sailing for many anti-ESG fund managers. One such fund manager, 2nd Vote Funds, has made the decision to liquidate its two ETFs — the Society Defended ETF and Life Neutral Plus ETF — with 2nd Vote citing an “inability to attract sufficient assets for operational sustainability”.
The Society Defended ETF was tailored to exclude companies opposing Second Amendment rights (of the US Constitution) and support for law enforcement, among other criteria. Similarly, its 'Life Neutral Plus' ETF abstained from investments in companies supporting abortion.
2nd Vote chief executive and founder David Black blamed the funds’ downfall on a lack of commitment by conservatives and Christians to counter the “successful radical ESG/woke/leftist agenda”, or due to a “failure in messaging”.
One issue facing anti-ESG funds broadly is in presenting compelling arguments that their mandates unlock value that other funds offer already.
This has seen them fail to gain any real traction with investors — only a few hundred million dollars are invested in US anti-ESG funds on a quarterly basis — compared to more than $6.6 trillion across all US ETFs last year.
And when compared to the US$315 billion ESG-fund market, the US$2.1 billion invested in anti-ESG funds is a drop in the bucket.
ESG investing remains imperfect
ESG investing isn’t without fault and investment in the class is also seeing flat growth, at least in the short term. But most of the opposition to ESG investing is in the terminology used and its measurement, rather than investors being against sustainability, social good or proper governance.
As head of global research at fund performance data provider Lipper, Robert Jenkins, said, “I’ve always wanted to see the end of that term [ESG], I think it’s horrible.
“If you’ve ever been down in the weeds and tried to calculate true ESG scores for companies, you find out how impossible it is to bring those three very different analytical pillars together into a single score that actually tells you something meaningful about the overall company.
"You have oil companies who know how to report into our overall metrics. And by the way, all the carbon-intensive industries, whether it be oil, mining or machine materials, are the most prolific reporters and they all write their own narrative into the methodologies of the various providers, and they know how to balance out the disclosures across the three pillars to give themselves a nice overall score.
“The idea around each of the pillars is still very important, and I’m a huge proponent of this space. But it’s gotten a little tired in the US and I think a lot of that is conflated by bipartisan issues, but ESG bonded on itself a little bit too, by having just such terrible metrics for people to look at.
“When you have a fracker getting an ‘A+’ on the environment and you have a company like Netflix (NASDAQ:NFLX) getting a ‘D-‘ on the environment, that makes no sense.
“It’s very difficult to measure, but I suspect there’s a bit of that showing up in our numbers. But it’s also important to note that overall, the market has had flat flows this year, it’s not just ESG funds.”
Time to rework the message
However, the anti-ESG backlash has not dissuaded asset managers and institutional investors from moving forward with responsible investing, according to a new report from Cerulli Associates — US Environmental, Social and Governance Investing 2023: Regulation and Legislation — although some are reworking their messaging.
No asset managers surveyed plan to stop incorporating ESG considerations into investment decisions or to stop offering sustainable investment products, but almost one in three intend to be more cautious about messaging in their marketing and investment documents.
Of the institutional investors surveyed, a small number (around 4%) intend to no longer invest in ESG funds and even fewer plan to stop incorporating ESG into investment decisions. Rather, a further 35% of institutional investors plan to offer responsible investing products and strategies in the next two years, adding to the 41% that currently do so.
As anti-ESG sentiment — and legislation — is often based on the assumption that asset managers are sacrificing investment returns to address non-financial considerations, Cerulli director Michele Giuditta says the solution is for managers to be “explicit about how relevant ESG data helps investors better evaluate the risk/return profile of investments to drive long-term economic value”.