IN-DEPTH: Deluge of Money Into ESG Funds Slows to Trickle

Investors cool on ‘sustainable’ investing after a year of disappointing returns

A mobile billboard opposing House Oversight Committee Republicans rolls past the U.S. Capitol in Washington on May 10, 2023. (Jemal Countess/Getty Images for Congressional Integrity Project)

The inflow of billions of dollars into ESG funds, which accelerated rapidly over the past decade, appears to now be stalling.

According to a report by Morningstar (pdf), a fund analytics firm that’s also among the top environmental, social, and governance (ESG) rating agencies, the number of “sustainable” funds available to investors increased by 12 percent from 2021 to 2022, but “flows into U.S. sustainable funds sank to $3.1 billion in 2022, their lowest level in seven years.”

The report also states that in 2022, “total assets in sustainable funds landed at $286 billion, a 20% decline from the all-time high of $358 billion at the end of 2021” and that “their 3.1 billion net annual inflow was well below the average $47 billion annual collection these funds had enjoyed over the previous three years.”

The travails of ESG funds are occurring in a very difficult year for investment funds in general. While “sustainable” funds grew by 0.9 percent in 2022, having grown by more than 30 percent in each of the prior two years, U.S. investment funds overall contracted by 1.3 percent in 2022.

Adding to the challenges, the performance of ESG funds lagged the market in 2022.

“Most sustainable funds underperformed in 2022, landing at the bottom half of the respective Morningstar Categories,” the report reads. “The biggest drag on performance was a relative underweighting to the energy sector.”

Chevron, America’s second-largest oil producer, reported a record $36.5 billion in profits for 2022, doubling its profits from the previous year. Exxon Mobil, America’s largest oil producer, also broke records, earning $56 billion in profit for 2022.

A financial report by Reuters states that “oil majors are expected to break their own annual records on high prices and soaring demand, pushing their combined take to near $200 billion.”

Morningstar defended ESG investing, however, stating that “one year of underperformance didn’t erase long-term outperformance.” If the year 2020 is factored in, a year in which energy stocks were hammered by societal lockdowns and a sharp decline in demand for oil and gas, then “sustainable” funds, which eschew energy stocks in favor of low-emitting industries such as tech and finance, would have delivered higher returns, according to Morningstar.

Speaking to Texas state legislators in December 2022, State Street Chief Investment Officer Lori Heinel told the senators, “I have no evidence that this [ESG investing] is good for returns in any time frame. In fact, we’ve seen the evidence to be quite contrary.

“Last year, if you didn’t own energy companies, you did miserably compared to broad benchmarks. The year before, that was quite the opposite ... but that was just a happenstance, that’s not because it’s a good investment.”

ESG Funds Empower, Enrich Wall Street

ESG funds typically charge higher fees than, for example, passive index funds that don’t require individual stock analyses by fund managers. While asset managers may be setting up new ESG funds out of sincere concern for environmental and social justice issues, there’s the added benefit that they make more money from them.

The Morningstar report also highlights the influence of ESG asset managers in compelling companies to get in line with their agenda. This mechanism is called “proxy voting,” or how asset managers vote the corporate shares their funds buy on behalf of the end investors in their funds.

According to Morningstar, the 10 largest ESG funds “supported more than 60% of the key ESG resolutions on which they voted in 2022. This ranged from 100% support (Parnassus Core Equity and Calvert Equity) to 20% (Vanguard FTSE Social Index).”

While ESG advocates have argued that shareholder proxy votes are largely symbolic and that corporate executives aren’t obligated to follow them, Morningstar found that “ESG-related proposals were fully implemented in 94% of cases where they achieved majority support. In three-fourths of cases where support was at least 30%, management acted on the proposal.”

However, some fund managers are less sanguine about ESG investing.

One fund manager, Inspire Advisors, has closed all of its ESG funds. In an August 2022 blog post titled “Biblical Investors Renouncing ESG,” CEO Robert Netzly explained why.

“We have removed ESG from the names of all our products and no longer identify our investment approach as being part of the ESG category,” Mr. Netzly wrote.

“For anyone who is unfamiliar, ESG is an approach to investing that seeks to ascertain potential risks and rewards inherent within an investment based on environmental, social, and governance criterion, which at face value is a rather benign concept. Unfortunately, ESG has become weaponized by liberal activists to push forward their harmful, social-Marxist agenda.”

Vanguard, the world’s second-largest asset manager, pulled out of the Net Zero Asset Managers initiative in December 2022, and in February, Vanguard CEO Tim Buckley said: “We cannot state that ESG investing is better performance-wise than broad index-based investing. Our research indicates that ESG investing does not have any advantage over broad-based investing.”

Larry Fink, CEO of BlackRock and a longtime advocate of ESG investing, said in June, “I’m not going to use the word ESG because it’s been misused by the far left and the far right,” noting that he was “ashamed of being part of this conversation.”

BlackRock ranked as the largest asset manager of “sustainable” funds for the past three years, followed by Parnassus, Calvert, Vanguard, and Nuveen/TIAA. While swearing off the term ESG, Fink said he was still a believer in “conscientious capitalism,” which some took to be the rebranding of similar policies under a different name.

ESG and Risk Management

In line with the argument that ESG investing is simply a matter of risk management, Morningstar stated that “sustainable funds continue to deliver lower levels of ESG risk” based on its own ESG risk rating criteria. In addition to risks that companies may face from rising temperatures, ESG advocates cite the role of government policy.

Major political developments in 2022 that were cited by Morningstar included a Biden administration rule handed down by the Labor Department that allowed ESG investing in private pension funds; the implementation of so-called green accounting requirements for all listed companies, as well as their suppliers and customers, by the Securities and Exchange Commission (SEC); and the SEC’s efforts to standardize ESG fund disclosures. Other areas where the Biden administration is supporting ESG investing include significantly tighter carbon dioxide emissions regulations from the Environmental Protection Agency on cars and electricity power generators and billions in subsidies for buyers of electric vehicles and for the construction of car battery plants.

However, corporate executives who pursue ESG policies may be exposing their companies to new risks, including racial discrimination lawsuits, antitrust actions, and overexposure to potentially adversarial countries such as China.

In May, attorneys general from 23 states requested information from 28 insurance companies as part of a potential investigation of violations of U.S. antitrust laws, as a result of the insurers’ memberships in anti-fossil fuel clubs such as the Net Zero Insurers Alliance and Climate Action 100+. On July 14, 13 conservative state attorneys general issued a letter to the CEOs of the top 100 corporations underscoring that the Supreme Court’s June 29 ruling against race-based admissions policies at Harvard and the University of North Carolina applied equally to racially discriminatory policies at private companies and that these companies would be in legal jeopardy if they violated federal or state civil rights laws.

In late July, attorneys general from New York, Illinois, Nevada, and four other states disputed this claim, arguing that the Supreme Court decision didn’t apply to employers’ diversity efforts and urging companies to continue to push for racial and gender equity. While the issue will likely ultimately be decided in court, employees are starting to win precedent-setting racial discrimination suits against companies.

In June, Starbucks, a coffee company, was ordered to pay $25.6 million to an employee whom a New Jersey jury determined was fired because she was white. And in May, three New York City employees sued the city pension fund for investing their retirement money according to ESG criteria, which the employees argue will reduce the funds available for their pensions.

Companies such as Disney, Target, and Anheuser Busch, brewer of Bud Light, have recently seen their sales share prices take a hit after taking up controversial social justice causes that alienated some of their customers. And while carmakers such as Ford and General Motors Co. have bet billions of dollars on constructing new electric vehicle (EV) battery assembly plants and pledged to convert most or all of their production to EVs in the coming years, consumer demand for EVs also appears to be stalling, leading to high dealer inventories and vehicle discounting.

Ford has been estimated to have lost approximately $60,000 on average for each EV that it sold in 2022. And industry experts, including Carlos Tavares, CEO of automaker Stellantis, formerly Chrysler, are skeptical that Western carmakers can acquire enough materials to manufacture EVs at scale, given that essential battery minerals such as cobalt and lithium are mined in countries such as the Democratic Republic of Congo and typically refined in China.

Some critics have argued that these issues may present more immediate and material risks for companies and investors than rising temperatures.