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A battle between some Republican lawmakers and proponents of ESG investing is heating up.
Environmental, social and governance (ESG) investing is an approach that accounts for businesses’ environmental and social risks and has become very popular in recent years, especially among young investors worried about climate change and social justice issues. ESG-related assets under management are expected to grow globally to $33.9 trillion by 2026, according to a recent report from PricewaterhouseCoopers.
A big argument from those who are pro-ESG investing is that the strategy is not only better for the planet — it also doesn’t hurt long-term returns. While many investors suffered in 2022, sustainable funds did better than their non-sustainable counterparts, netting more than $3 billion, according to Morningstar. Advocates say investing this way helps lower certain risks, like the long-term impacts climate change will have on businesses.
But many critics aligned with the Republican party are pushing back on investment firms that use this approach, saying that it supports so-called “woke” politics that not everyone agrees with. And that pushback could result in fewer options in 401(k)s and state pensions, says Blaine Townsend, director of sustainable, responsible and impact investing at investment management firm Bailard.
"It will have a chilling effect,” Townsend says. “The markets in general function best when elected officials or politicians aren't using their bully pulpit to affect the way capital flows in the markets.”
The fight for and against ESG
Why exactly are some GOP officials anti-ESG? It comes down to politics.
These lawmakers say that, by incorporating ESG, large asset managers like BlackRock and Vanguard are pushing a liberal agenda on state pension funds and defined benefit plans like 401(k)s. As former Vice President Mike Pence put it via an opinion piece in The Wall Street Journal last year, “the woke left is poised to conquer corporate America and has set in motion a strategy to enforce their radical environmental and social agenda on publicly traded corporations.”
Wealth managers say they aren’t supporting an agenda and that taking ESG issues into account is beneficial for stakeholders in the long term. Larry Fink, BlackRock’s CEO wrote in his annual letter to CEOs last year that stakeholder capitalism — the idea that business should serve the interests of all stakeholders like customer and employees, not just business profits and shareholders — is “not about politics.”
“It is not a social or ideological agenda. It is not ‘woke,’” Fink wrote. “It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper.”
For years, there’s also been debate around how ESG compliance is measured. Because there are many data providers and a wide variety of metrics, there are no set standards or procedures. That’s raised concerns of “greenwashing” — as in, companies saying they are doing rigorous ESG analysis without actually having sustainable practices or products.
What’s the current state of the ESG debate?
A recent rule from the Biden administration permitted fiduciaries — financial advisors who are legally obligated to work in the best interest of their clients — to consider climate change and other social and governance issues when selecting retirement investments for their clients.
In response, several Republicans have moved to prohibit fund managers from considering ESG factors.
Around 25 state attorneys general filed a lawsuit in January alleging that the rule undermines the protection of retirement savings, and Florida Gov. Ron DeSantis introduced legislation this week that would prohibit the state from using ESG to make financial decisions. Other states, like Texas, have also made moves to block state fund managers from putting their money in funds or companies that make investment decisions based on ESG measures. Meanwhile, an anti-ESG working group was formed by the House Financial Services Committee to coordinate a response to the rise in ESG investing.
These Republican lawmakers say their pushback comes from wanting investors to have a choice, says Loreen Gilbert, CEO at WealthWise Financial Services.
Large players in the investment industry “can control a lot of what's going on in industries and companies by imposing subjective standards versus quantitative metrics,” she says. The anti-ESG sentiment we’re seeing now is in support of these metrics not being imposed on investors, she adds.
Townsend says the demand for ESG investing isn’t about ideology but about institutional investors wanting more information about systemic risks.
“The anti-ESG perspective that’s being offered is really not new,” he adds. “The way things are approached now makes this version of it probably a little bit more ideologically based and a little bit louder just because of how polarized politics have become in general.”
What this means for investors
Right now, employer-sponsored savings plans like 401(k)s don’t tend to offer a ton of choice to participants — including when it comes to ESG investments.
“The vast majority of 401(k) plans or qualified plans have no sustainable investment options,” says Nick Cantrell, founder and wealth advisor at Green Future Wealth Management. “So for most investors who want to invest sustainably, they're doing it outside of their qualified plans.”
In other words, there likely won’t be a big impact on your current employer-sponsored retirement savings plans, unless it is one of the few that includes an ESG offering.
But the current battle could impact any change to future offerings.
“It could have the possibility of limiting ESG or sustainable investment options within qualified plans, if plan administrators go back to being afraid or still are afraid that they'll be the target,” Cantrell says.
If you want to have a better understanding of what you are investing in via your retirement plan now, Kavan Choksi, managing director at KC Consulting, suggests reaching out to the plan administrator for details. But, he adds, “understand that it is unlikely it will lead to a change unless there is broad support among your organization for such a change.”
For now, the best option for investors interested in ESG investing — and having more control over where their money is going than they may be getting with their 401(k)s — is to do so on the individual level, like in an individual retirement account (IRA), Choksi says.
Analyzing and buying individual stocks is challenging, and can be risky, but there are many ESG-oriented funds. Fidelity Investments, for example, offers the Fidelity U.S. Sustainability Index Fund, and BlackRock offers the iShares ESG Aware MSCI USA ETF.
Morningstar also has a list of its top funds for sustainable investing.