Unsurprisingly, in the US the Republican Party has taken on the proverbial mantle. Accusing ESG managers (and investment leviathan BlackRock, in particular) of being “anti-capitalist and anti-American”, Florida and Louisiana’s treasuries pulled $3-billion away from BlackRock last month, declaring the manager to be “hostile”. 

While most rancorous in oil-producing red states like Texas, where officials have called out what they see as overly “woke” behaviour by the asset manager, such sentiments are increasingly reaching Congress. The battle lines have been drawn.

However, former devotees are also starting to criticise the ESG circus, questioning the very tenets of what it purports to achieve. The former CIO of sustainable investing at BlackRock, Tariq Fancy, has written a damning piece arguing that the ESG project is intellectually bankrupt and is damaging to the causes it purports to support. 

Robert Armstrong, writing in the Financial Times, recently argued: “ESG investing is dangerous. The reality is that the ESG industry is a massive fee trough for fund managers, consultants and the rest of the industry, and all of those fees come out of well-intentioned investors’ pockets.”

There are three main reasons often cited as to why ESG is a con. 

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First, underpinning ESG investing is an assumption, clarified in an open letter from BlackRock in 2020, that “sustainability and climate integrated portfolios can provide better risk-adjusted returns to investors”. Over time, essentially, more virtue equals more money for investors, who can “do well by doing good”. The problem is that this is simply not true. According to reports from the International Monetary Fund, there is no proof that ESG funds do better than non-ESG ones. Indeed, as ESG fund fees are usually higher, they would tend to ensure lower returns for investors.

Second, acolytes argue that ESG changes the world because with more investors allocating their capital to “green” companies it lowers their cost of capital, essentially making it cheaper for them to do “good things”. 

The problem is that this argument is not often made by ESG investment firms because it runs contrary to their primary assumption of these products, which is that investment performance in an ESG fund is better than in a non-ESG one. When you pay more for future cash flows, that lowers your expected return. ESG investing, therefore, could only make the world a better place by offering investors lower expected returns.

Third, advocates of ESG argue that the performance of their funds is better because such ESG considerations improve the long-term profitability of companies. But is this not the job of all investment managers anyway? If ESG investing did provide higher returns — as the industry both explicitly and implicitly promises — then would profit-seeking investment managers not be doing all this work anyway? 

A corollary often argued is that ESG investing is a form of risk management. But are not all money managers in the risk management business? Have they not noticed that the occurrence of extreme climatic events is increasing, or that cigarettes kill their users? Do they need a reminder from the ESG team that British American Tobacco has question marks around the longevity of its business model?

Finally, and most fundamentally, ESG gives investors the impression that shifting their savings from one investment fund to another is going to help materially with, say, the climate crisis. This creates a dangerous distraction from solutions that fit the scale of the problem, all of which involve changing the rules of capitalism. ESG investment products effectively crowd out the essential reforms and investments needed to actually change the macroeconomy.

One does not have to be a Republican zealot to be wary of the ESG fad. We have a very good, if presently neglected, set of tools to ensure that everyone sustainably shares in the fruits of economic progress. They are democratic action and the rule of law, which allow us to, for example, tax carbon emissions. Attempting to protect an investment portfolio from the disastrous effects of climate change is not the same thing as preventing those disastrous effects from occurring in the first place. Unfortunately, that is clearly a far more difficult and less profitable endeavour. DM