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Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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ESG Investing: From Top Opportunity To Risk

Earlier this week, a Republican bill aimed at preventing pension funds from making investment decisions on the grounds of climate change considerations passed in both houses of Congress. While many expect President Biden to veto the bill and have it all done with, the existence of this bill is a sign of a changing tide—a pushback from conservative U.S. politicians against the ESG investment drive that has been gathering momentum for the past few years. 

The pushback is not just in Congress, either. In fact, it is much stronger outside Congress. Several states have set their sights on ESG investments and the firms that promote them. Texas and Kentucky are two good examples with their warnings for asset managers to either give up ESG—and the vilification of oil and gas—or lose Texas and Kentucky money. That's how ESG investing turned from an opportunity to a risk.

The Financial Times reported this week that the growing backlash against ESG investing has become a material risk for the profits of asset managers and private equity firms active in that sort of investing.

The report cited annual reports by firms such as BlackRock, Blackstone, KKR, and T Rowe Price, saying that these included for the first time warnings that "divergent views" and "competing demands" on ESG could affect bottom lines.

The "divergent views" have already led to some conservative U.S. states to pull out some $4 billion from BlackRock alone, the FT notes, adding asset managers are also being subjected to probes and investigations into their ESG practices. Even their shareholders are not of a single mind when it comes to the principles of environmental, social, and governance investing. And with a good reason.

In this article, Diane Katz, a research fellow at the Heritage Foundation, a conservative think tank, analyzes ESG investing trends and notes that critics attack ESG for prioritizing stakeholder benefit over shareholder value, which goes against the principles of sound investment, and it also creates an opaque environment abundant with opportunities of greenwashing.

In another article—this one for the Harvard Business Review—finance professor Sanjai Bhagat makes an even more disturbing revelation: ESG investment does not drive higher returns, as claimed by many ESG advocates.

Related: Coal May Be Dying, But America Still Needs Oil And Gas

Bhagat cites research that has found that ESG-focused funds had lower returns than traditional ones. It also found, startlingly enough, that companies with an ESG designation had an even worse record in environmental regulation and labor legislation compliance than their non-ESG-focused peers.

No wonder Morningstar, which provides ESG designation services, had to strip 1,200 funds of that designation after studying their ESG credentials closely. Those funds managed $1.4 trillion in assets.

Adding to evidence that the ESG funds' equal higher returns narrative may not be true after all, Bloomberg reported last December that ESG funds underperformed the S&P 500, with the ten largest among them booking double-digit losses for 2022.

Interestingly, researchers from the National Bureau of Economic Research recently suggested that returns are not the most important thing for some ESG investors, and the higher fees that ESG funds carry are not a big problem. Their top priority appears to be the sense of satisfaction they get out of investing in ESG funds.

Per the study's authors, "When we incorporate the possibility that investors are willing to accept lower financial returns in exchange for the psychic and societal benefits of ESG, we find that the implicit value that investors place on ESG stocks is higher still."

Yet while this may hold true and be fine for individual investors operating with their own money, things are different when it comes to pension funds operating with the retirement money of millions of people. And the conservative backlash against ESG has made pension funds a central factor in their campaign.

The Wall Street Journal reported last month that conservative activists are building a national campaign against ESG investing in a way similar to the way they campaigned against critical race theory, attacking it as the politicization of investing.

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How the fight will end remains to be seen, but it is a fact it is intensifying and making investment majors reconsider what they must have thought was a clear path forward on the ESG bandwagon. Looking at the banking industry might be helpful: despite loud and ambitious net-zero commitments, the world's banking giants are still more exposed to fossil fuels than their alternatives.

A recent BloombergNEF study revealed that the likes of JP Morgan, Wells Fargo, Bank of America, and Citigroup—all members of the Net-Zero Banking Alliance—all invested more in oil and gas than they did in low-carbon energy companies, even though the difference wasn't too big. The ratio of low-carbon to high-carbon exposure was 0.97:1. However, Bloomberg notes, the NZBA has pledged a ratio of 4:1 in favor of low-carbon investment by 2030. That should be as interesting as the ESG war.

By Irina Slav for Oilprice.com

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