Why anti-ESG policies are bad for investors

What’s happening? Florida’s $186bn pension fund has been barred from considering environmental, social or governance (ESG) factors when making investment decisions. The rule was approved by the state board of administration’s three Republican trustees on 23 August and will become codified in law. Governor Ron DeSantis said ESG policies were “dead on arrival” in the state and that the fund was to invest with the goal of “maximising financial return over and above other considerations”. The fund has lost $20bn this year. (S&P Global)

Why does this matter? Considering ESG information related to an investment is important, as most asset managers realise. And not just from a societal perspective – it helps managers meet their fiduciary duties to their clients by avoiding key longer-term (and some shorter-term) risks. However, as certain US states introduce anti-ESG policies it becomes difficult for investors to do this and, consequently, their clients’ investments will face higher risks.

Not just Florida… Idaho and West Virginia have also both introduced rules which may prevent public pension funds from considering ESG.

The news from Florida follows the Texas Comptroller releasing a blacklist of companies that Texas considers hostile to fossil fuels. State pension and school funds will be required to divest from these firms. Some of the financial institutions on the list include BlackRock, Credit Suisse, UBS and BNP Paribas. There is also a second list of 350 individual funds that Texas state investment funds are not allowed to invest in.

Many financial institutions and market participants have been criticising Texas’s move – BlackRock has said its blacklisting by Texas was “anti-competitive”. The firm also emphasised that it does not boycott fossil fuels, and said it has invested $100bn in Texas energy firms.

Bad for business – Morningstar’s director of sustainability research, Jon Hale, has said the actions of these Republican politicians are bad for business and for investors. Hale also said that the anti-ESG policies are an attempt by state politicians to protect the fossil fuel industry from the free market. If investors want to pour more money into firms performing better on ESG, they should not be prevented from doing that.

Impact on pensions – The states are essentially demanding investors ignore climate risks, however, as we’ve discussed previously, climate risk is a financial risk – and it’s critical it is considered in the investment process. If not, people’s pensions are likely to suffer from significant climate-related transition and physical risks in the future.

The anti-ESG policies will also likely mean state pension funds will continue to invest in fossil fuel assets that pose a significant stranded asset risk. A study has estimated that nearly 50% of the world’s fossil fuel assets could be worthless by 2036 as the world moves towards net-zero emissions.

Anti ESG on the rise? There has also been a rise in anti-ESG shareholder proposals filed at US firms, however the majority have received little support from investors. Morningstar’s proxy database noted that 43 such proposals were filed by the National Legal and Policy Center, the National Center for Public Policy Research and Steven J Milloy, with average support of just 7% from shareholders between January and June.

The future – How far this anti-ESG backlash will go in the US remains to be seen – most stakeholders are sticking with ESG for the time being and there’s no indication this will change. Indeed, investors both institutional and individual are showing a growing interest in sustainable investing, as a survey from Morgan Stanley indicates.

States that do not realise this are not moving with the times.