ESG Investing: What is it?

The three-letter acronym has been tossed around regularly in the past few years and has come under intense scrutiny as of late.

ESG investing, also known as sustainable or socially responsible investing, is an approach to investing that takes into consideration environmental, social, and governance factors when evaluating companies or investment opportunities.

• Environmental (E) factors: This aspect focuses on assessing a company’s impact on the natural environment. It includes considerations such as carbon emissions, climate change policies, energy efficiency, waste management, pollution, and resource conservation. ESG investors typically favor companies with strong environmental practices and a commitment to sustainability.

• Social (S) factors: Social factors involve evaluating a company’s impact on society and its stakeholders. This includes examining labor practices, human rights, employee well-being, diversity and inclusion, community relations, product safety, abortion rights, LGBTQ+ rights, and customer satisfaction. ESG investors often prioritize companies that exhibit ethical behavior, fair treatment of employees, and a positive societal impact.

• Governance (G) factors: Governance factors relate to the way a company is governed, managed, and controlled. This includes assessing board structure, executive compensation, shareholder rights, transparency, ethical standards, and anti-corruption policies.

ESG investing incorporates these factors into investment decision-making to identify companies that align with certain sustainability or ethical goals. This approach considers both financial performance and non-financial indicators to assess a company’s long-term prospects and potential risks. ESG investors seek to support companies that demonstrate a commitment to sustainability, responsible business practices, and positive societal impact, subject to what they consider the definition of each of these factors.

Pros & Cons
The upsides of ESG investing are that those who view many of the ESG factors as absolutely critical to their own values may prioritize these factors by choosing to invest in asset management companies that will invest their capital according to the ESG criteria. Having a wide array of choices has always been a strong point of our nation, and those who value ESG investing should be able to invest their money how they choose.

The downsides of ESG investing: There are many conflicting studies published on the performance of ESG-centric investments, this is due in part to the limited amount of data available on these relatively new investments. What can be concretely observed is that ESG investments are more costly than their non-ESG counterparts.

“According to a new Harvard study, on average, ESG funds have 68% of their assets invested in “the exact same” holdings as non-ESG funds. So, for every dollar you invest in an ESG fund, a little less than a third goes into stocks you could have gotten in a fund that isn’t ESG. The average ESG U.S. stock ETF charges 0.17% in annual fees, according to Morningstar, 0.05 percentage points more than non-ESG funds… Therefore, you’re really paying three times as much for the thing you care about, the differentiated piece of the portfolio. (Per Nasdaq)” Investors who find many of the ESG factors of essential importance may be overpaying an asset management company who is overpromising and underdelivering on many of their ESG investments (known as Green-Washing).

Another notable drawback of ESG investing is that asset managers can, and do use investor capital to push their politically motivated agenda without the knowledge of the investor (known as Green-Smuggling). This means that although an investor may not agree with many of the ESG values that this form of investing seeks to prioritize, the asset manager will use the investor’s monies to do so anyway. This has been especially evident from Larry Fink’s BlackRock, who has admitted to illegally pushing ESG investing:

“…In August, nineteen attorney generals accused BlackRock of illegally using client money to push ESG goals. In December, the Texas legislature pilloried BlackRock on ESG. Even Elon Musk has called ESG a “scam” that has been “weaponized by phony social justice warriors.”

The backlash hit BlackRock hard. Eight state treasurers have pulled billions of dollars. Texas blacklisted the company. After years of growth, BlackRock’s US ESG funds had zero net inflows last year. Amid the fallout, Mr. Fink’s 2023 letter strikes a different tone. Gone are proclamations that “every government, company, and shareholder must confront climate change” and “racial justice . . . cannot be solved without leadership from companies.” “Stakeholder capitalism”—a central theme of last year’s letter—has vanished. “ESG” is gone; “sustainability” appears just once. BlackRock even acknowledges that not all clients want their investment money used to accelerate climate goals.”

 

• “Green-Washing”: a practice where companies (oftentimes asset managers) mislead the public by telling them that they are investing in “ESG-centric” types of ideas and/or investments, though they are not actually abiding by such criteria. Only recently has the SEC begun to crack down on this practice by issuing fines for attempting to carry out this deception.

• “Green-Smuggling”: the practice of using client funds to purchase “ESG-centric” investments without the client’s expressed consideration, and then using the client’s assets to vote in favor of “ESG-centric” measures within boardrooms to force company change. For example, BlackRock has only ~5% of their total investable products labeled as “ESG,” though they vote the same for 100% of the assets they currently manage.

 

So, how do asset managers such as BlackRock illegally use others’ money to push their own views on companies? The answer is simple, Proxy Votes and threatening companies to withdraw funding if they do not abide by certain ESG factors. Considering the largest three asset managers control roughly $20 trillion, they can have quite some sway over how companies operate.

“Shareholders are the owners of companies and have the right to vote each year on proposals governing them. This fact used to be well-known, but over the last century many Americans have forgotten that shares come with voting rights attached. The rise of passive investing (ETFs, Mutual Funds) has transferred legal ownership of shares of public companies from individual investors to the asset managers who offer them index funds.

Recently, thanks to their embrace of stakeholder capitalism, large asset managers have begun to use the power of the proxy vote to advance social and political causes. This means that they are using their clients’ money to support other peoples’ interests.”

What’s more concerning are the comments made by BlackRock’s Larry Fink involving his firm’s use of ESG investing, as noted during an interview at a conference on June 25, 2023 (per Axios): 

What’s new: In a conversation at the Aspen Ideas Festival on Sunday, Fink acknowledged that Florida Gov. Ron DeSantis’ decision to pull $2 billion in assets hurt his firm in 2022, but made clear last year was his company’s best net flows of $200 billion from U.S. clients.

What he’s saying: “I’m ashamed of being part of this conversation,” Fink said.

“When I write these [investment] letters, it was never meant to be a political statement. … They were written to identify long-term issues to our long-term investors,” he told the crowd.

Yes, but: When pressed on the statement later in the conversation, Fink backtracked.

“I never said I was ashamed,” he said, incorrectly. “I’m not ashamed. I do believe in conscientious capitalism.”

“I’m not going to use the word ESG because it’s been misused by the far left and the far right,” he added.

Legal Concerns
In addition to our concerns of asset managers promoting companies to act according to their ESG criteria, rather than fostering operational excellence, there are legal concerns that have yet to be pursued due to the relatively new introduction of ESG in the industry. These legal issues do not just concern corporate asset managers, but they also warrant consideration for those who have a Fiduciary obligation to their clients (us!). By defaulting to invest clients’ assets in various investment vehicles that may or may not be seeking to maximize returns, Fiduciaries are violating their obligatory duty. The section below outlines how many of these trillion-dollar managers are riding a fine line of breaching their sworn duties.

“Section 13(d) of the Exchange Act mandates that individuals or entities owning more than 5% of a publicly traded company must report their stake to the SEC. The report should include details of the acquisition, recent trades in the relevant securities, and the acquirer’s intentions regarding the company, such as plans for changes in directors, asset sales, or other significant alterations to the company’s business. An updated disclosure must be filed if the holdings change by more than 1%. However, prominent asset management firms like BlackRock do not comply with Section 13(d) and instead use Schedule 13G, which has less strict requirements and only needs to be updated once a year. By doing so, they avoid reporting prior trades and intentions. Although these firms argue that they have no intention to influence or control the companies, their efforts in promoting environmental, social, and governance (ESG) initiatives contradict this claim. Through activities like proxy voting and corporate engagement, these firms seek to advance their ESG agenda, which can significantly impact companies’ decision-making and may go against the best financial interests of the company and its shareholders. Private parties and state attorney generals have the right to sue under Section 13(d) to enforce federal securities laws, and state attorney generals can also file lawsuits under state laws to protect investors and consumers. In summary, the ESG activities of large asset management firms likely violate Section 13(d), and state attorney generals have the authority to take legal action to address this violation.”

Operating as a Fiduciary: Profits over Politics
In everything we do as a firm, we always prioritize our client’s best interests. This manifests itself in striving to maximize our client’s financial wellness given the tools at our disposal. We are solely interested in investing monies in such a way that promotes excellence over any consideration for politics. We are not politicians, we are financial planners who are only concerned with growing our client’s net worth, any other factors completely fall by the wayside. Unless specifically requested, we will allocate capital to companies that use Proxy Voting in such a way that seeks only to earn maximum returns. As the investing landscape continues to evolve, we will continue to educate ourselves on these changes and re-allocate the assets with which we have been entrusted in such a way that is positioned for success over all else.

We would also like to wish all of our valued clients a safe and joyous Independence Day, as we celebrate the birth of our great nation.

In God We Trust,

The McIlrath & Eck Team