Shareholder Advocacy Review – Winter 2023

Touching a Nerve

First, the good news: the U.S. Department of Labor issued its final rule last month replacing Trump-era guidance that had stymied the ability of pension and other retirement plans to include environmental, social, and governance ESG factors when selecting investments. The new rule, “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights,” allows retirement plan fiduciaries to consider ESG in their risk and reward analysis of prospective investments.

The rule also indicates that fiduciaries are not prohibited from selecting investments or using strategies based on collateral benefits other than investment returns. Perhaps ironically, this new flexibility is quite “conservative” in that it allows investment professionals the freedom to determine how to define potential risks and rewards rather than the government prohibiting it. Of course, extremist Republicans will still blow their tops over this development, as they see it as another example of elitist liberal wokeness that interferes with the purpose of capitalism (and we all know what they mean).

When socially responsible and ESG investing were in their infancy 30 years ago, conventional finance stalwarts rejected their tenets as socialistic rather than sound investment analysis. Over the ensuing decades, however, the overwhelming popularity of this approach moved it to the center of the financial system, and today the largest investment firms in the world, and the financial press that once critiqued it, now embrace it as a legitimate way to address the myriad risks affecting share value. This development has made responsible investing a real threat to the exploitive legacy operators within capitalism that want the freedom to continue making money regardless of the social and environmental harms they cause; they certainly don’t want to face any scrutiny when investors divest or exclude them from investment consideration.

Recent critiques of environmental, social, and governance (ESG) investing from the likes of Elon Musk, former vice-president Pence, and other senators, governors, and treasurers of conservative states include false accusations. For example, the Republican Study Committee in July published a Memorandum titled “The War on American Energy: Ground Zero,” falsely declaring that ESG investors take positions on social and political issues that have nothing to do with business.

It shouldn’t be too surprising that ESG critiques largely derive from states that feature destructive industries such as fossil fuels, so their leaders are obviously trying to protect their states’ economic interests. But the objection to ESG is more than that – they believe that ESG proponents are out to harm or destroy companies by encouraging them to adopt more responsible practices. They believe it’s all based on a left-wing political strategy to ignore the “real” interests of businesses rather than act on the basis of what consumers and investors want and demand from the companies they patronize and own.

This would be funny if it weren’t so ignorant, but political echo chambers are consistent in their conspiratorial themes. If they truly believe that consumers and the general public aren’t seriously concerned about corporate behavior, climate change, worker rights, fair wages, clean air and water, and diversity in all aspects of company management and ownership, they are truly living in an alternate reality.

Refuting the notion that sustainable investing is irresponsible, ineffective, or partisan in nature, our trade association, US SIF, recently launched in an effort to set the record straight on what sustainable and responsible investing is, in particular to highlight its primary focus on long-term competitive financial return.

ESG Factors
Source: Morgan Stanley

The site shares the results of the Morgan Stanley poll that illustrates the overwhelming majority of investor support for sustainable and responsible investing based on the notion that the public wants companies to be good actors. It is entirely reasonable to look at all types of investment risk, which is why the majority financial analysts now include ESG information when assessing and recommending investment opportunities. The research has been clear for 20 years that ESG factors are material to financial performance – including in a recent Morningstar study, so it is an imprudent breach of fiduciary responsibility to ignore them.

Employees, communities, the environment, and customers affect the bottom line, so those of us who understand the inherent risks in ignoring these aspects of business are not the enemy of capitalism. And yet, conservative state administrations and legislatures are currently passing laws to exclude investment managers using ESG approaches, all of which is a clear ruse to protect industries whose existence poses a threat to humanity. For example, Texas passed a law that bars local authorities from doing business with banks that have adopted ESG policies and divested from Texas fossil fuel-based energy companies. Florida also adopted a rule on ESG in the state pension plan.

These authoritarian policies, which also include voting rights restrictions, gerrymandering, judicial appointments, limiting of women’s rights, the admonishment of Black Lives Matter and critical race theory, and evolving gender norms, are largely viewed by the business community
as extremism that fosters political instability and is therefore bad business.

The business community operates in and sells to numerous jurisdictions that are already voluntarily addressing social and environmental risks and embracing appropriate notions of corporate responsibility. Companies with strong ESG performance can also achieve lower cost of capital, per an MSCI study showing that companies with high ESG scores, on average, experienced lower costs of capital compared to companies with poor ESG scores

in both developed and emerging markets. The cost of equity and debt followed the same relationship. The key issue conservative politicians need to understand is that companies’ strong management of financially relevant ESG risks is aligned with investor interests. The economy is greening faster than ever, there’s no turning back. As more Americans turn to electric vehicles, solar panels, sustainable and green building technologies, green chemistry, natural fibers, and biotechnology, they are seeking investments in companies that can address structural and systemic risks while finding innovative opportunities that are adaptive to climate change and facilitate a more sustainable economy.

As such, we must all inform our elected and appointed officials that ideologically motivated political posturing that undermines investment choices is a form of social control that is bad for free enterprise and investors. Let your state and national leaders know that more investors are voting with their dollars and seeking investment opportunities that match their values, and that we expect government to not interfere with the freedom of choice that a free market requires.

Here are some important industry studies:

Morgan Stanley:

JP Morgan:

And a few research studies:

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