As ESG Comes Under Scrutiny, Skeptics and Contrarians Rise Up

SEC climate disclosure proposal is among the targets
By Nathan Worcester
Nathan Worcester
Nathan Worcester
Nathan Worcester is an environmental reporter at The Epoch Times. He can be reached at nathan.worcester@epochtimes.us. Follow Nathan on Twitter @nnworcester
June 20, 2022 Updated: June 21, 2022

Environmental, social, and governance (ESG) principles have rapidly taken hold in the financial sector in recent years.

Now, against the backdrop of increasing regulatory enforcement, rising anti-ESG activism, and criticism of the Securities and Exchange Commission’s (SEC’s) climate disclosure proposal, ESG skeptics are coming to the fore, pushing back against the SEC and developing new financial products that buck the ESG consensus.

In recent weeks and months, authorities have started cracking down on ESG funds that are allegedly misrepresenting their products.

German prosecutors raided Deutsche Bank and asset manager DWS on May 31 over accusations of “greenwashing”—exaggerating the environmental soundness of some of their investments.

The action came just a week after Bank of New York Mellon Investment Adviser Inc. paid a $1.5 million fine to the SEC over similar claims of greenwashing in connection with mutual funds it managed.

“From July 2018 to September 2021, BNY Mellon Investment Adviser represented or implied in various statements that all investments in the funds had undergone an ESG quality review, even though that was not always the case. The order finds that numerous investments held by certain funds did not have an ESG quality review score as of the time of investment,” the SEC wrote in a May 23 press release.

The SEC has also launched an investigation of Goldman Sachs’s ESG funds, as reported on June 10 by The Wall Street Journal.

“Goldman Sachs is cooperating with the SEC on this matter,” a spokesperson for the company told The Epoch Times.

In addition, Republican politicians in energy-producing states have started coordinating their response to ESG. Many say it has helped drive divestment from the fossil fuel sector, punishing their local economies.

West Virginia State Treasurer Riley Moore and Utah State Treasurer Marlo Oaks have led the charge against ESG investments of public pension funds and related developments aimed at subjecting energy-producing states to ESG-based criticism—for example, S&P Global’s use of ESG to assess states’ credit scores.

Riley argues that greed has helped to drive the ESG movement in finance.

“The administrative fee on your ESG ETF [exchange-traded fund] is almost twice as much as your large-cap S&P 500 ETF, so, of course, asset managers love the ESG ETF because they’re getting paid. And it’s all getting passed down to the pension holder and the consumer. They’re subsidizing this entire social experiment. They’re playing with other people’s money,” Moore said in a June 8 interview with The Epoch Times.

Jerome Dodson, founder of Parnassus Investments and a pioneer in ESG, agreed that many funds advertising themselves as ESG may be motivated by the opportunity to earn more in management fees.

“They use [ESG] as a marketing technique, and they are charging a higher expense ratio,” he told The Epoch Times in a June 17 interview.

He said he wasn’t shocked to see Goldman Sachs and Deutsche Bank under regulatory scrutiny for alleged fraud and similar alleged actions, describing the companies as the “usual suspects” when it comes to insincere ESG activity.

Goldman Sachs didn’t comment on Dodson’s statement.

Meanwhile, the comment period for the SEC’s controversial climate disclosure proposal ended June 17.

The SEC’s ESG-friendly prospective rules, first announced on March 21, 2022, include sweeping greenhouse gas disclosure requirements.

SEC Chair Gary Gensler and supporters of the potential rules argue that the rules are broadly in line with climate reporting by many large firms. Advocates claim the new reporting regime would standardize the information many investors already use, while better addressing what they see as massive and unprecedented risks from human-caused climate change.

“By meeting investor demands for disclosure, transparent companies will be more competitive, innovative, [and] clean. Climate disclosure is a critical step to help companies get ready for a net zero carbon economy,” states Ceres, a sustainability nonprofit, on a webpage instructing its audience to send positive comments about the rule to the SEC.

Opponents assert the rules go beyond the SEC’s mission (“to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation”).

In particular, many charge that the proposed requirements violate the First Amendment and distort the definition of “materiality” by requiring information that many investors wouldn’t see as relevant to their decision making.

The SEC has estimated that its new rules would increase compliance costs for businesses from $3.9 billion to $10.2 billion. While some argue that estimate may be too high given how many companies already report climate-related information, others claim the SEC’s estimates fail to account for many other costs that the rules may impose.

Paul Ray, director of The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies and “regulations czar” in the Trump administration’s Office of Management and Budget, worries the SEC understates the true costs of its proposal.

He believes the greenhouse gas emissions rules would impose a particularly significant burden on small businesses that work with publicly traded companies.

“The Scope 3 emissions disclosure requirement would require publicly traded companies to demand that many of their suppliers and customers report to the publicly traded companies, to be passed on to the SEC, what their GHG [greenhouse gas] emissions are,” Ray said during a June 15 interview with The Epoch Times.

“We’re looking at a cost to small businesses that is not quantified. And it’s going to be very, very hard for small businesses to bear.”

He also thinks the rules would discourage companies from going public, making it more challenging for smaller investors to get in on the ground floor of promising new startups.

“We’re looking at making it more difficult for companies to access public markets and making it more difficult for Americans to save for retirement,” Ray said.

Contrarians and Alternatives

As this pushback on ESG has intensified, some see an opportunity to beat a politically correct market.

One is value investor Mark Neuman, founder of Constrained Capital.

Neuman created the ESG Orphans Index, a new ETF focused on stocks that the ESG movement frowns on, including those in fossil fuels, nuclear energy, weapons, and tobacco.

Its holdings include Exxon Mobil, Chevron, Raytheon Technologies, and Anheuser-Busch.

In a June 13 interview with The Epoch Times, he pointed out that Altria, a major tobacco company, significantly outperformed the S&P 500 index between 2002 and 2017.

By contrast, the S&P 500 had often outperformed Altria from mid-1998 through mid-2000, the period after the 1998 Master Settlement Agreement between tobacco companies and attorneys general from most U.S. states.

Neuman believes that the constraints on capital flowing to tobacco ended after California’s public pension system, CalPERS, and other pensions fully divested from tobacco during the early 2000s.

He thinks that ESG’s emergence around 2017 began to limit the tobacco industry once again, leading Altria and similar firms to perform below the S&P 500 in subsequent years.

“That’s, to me, when the ESG bubble was imposing massive capital constraints on tobacco,” he said.

Neuman thinks the sin stocks and “woke shame stocks” that ESG funds have excluded are on track to provide massive returns “because they’ve been so beaten and disregarded, and left for dead.”

“People are going to eventually realize that money needs to be stored in the place where it’s getting the best returns, not where we feel good about it,” he said.

He expects the ongoing regulatory crackdown on ESG will help spur investors to invest elsewhere.

Neuman questioned the values incorporated into ESG scoring, citing the relatively strong performance of snack food giant Mondelez International on those metrics.

“How’s that contributing to our society in terms of obesity and diabetes?” he said.

Dodson, of Parnassus, doubts the wisdom of a fund made up of non-ESG stocks, saying that others tried and failed, decades ago, using a comparable approach.

He couldn’t immediately name the funds he had in mind.

“None of them really got off the ground at the time. A lot of us thought it was a joke,” he said.

“They’re probably trying to find a market niche, but I suspect they won’t be very successful.”

Some research, such as one 2009 analysis, has concluded that “sin funds” don’t perform unusually well.

Yet, other investigations, including a major 2008 article, have found that sin stocks have historically performed well.

Aswath Damodaran, a finance professor at New York University and another influence on Neuman, pointed out that Vanguard’s Vice Fund had significantly outperformed a socially conscious fund between 2002 and 2015.

Damodaran, like Neuman, is an ESG skeptic, describing ESG as a “feel-good scam.”

In a March 2022 blog post, he asserted that Russia’s invasion of Ukraine further exposed the weaknesses of ESG, including in its approach to the energy sector.

“It is true that the emphasis on climate change that skews ESG scores lower for fossil fuel and mining companies would have kept you from investing in Lukoil and Gazprom, among other Russian commodity companies, but it would also have kept you from investing in other companies in these sectors, operating in the rest of the world,” Damodaran wrote.

“If there is a lesson that this crisis has taught us, it is that treating fossil fuel producers as evil, when they produce much of the energy that we use, is delusional.”

Others concerned about ESG have developed their own impact investing funds, focused on values that differ from, and sometimes conflict with, traditional ESG.

Amberwave Partners, founded by three alumni of the Trump Treasury Department, falls into this category.

The asset manager’s iUSA fund, launched in January, aims to further the interests of the United States and American communities.

In place of ESG, it’s built around JSG: jobs, security, and growth.

Amberwave co-founder Dan Katz told The Epoch Times that the JSG framework is not as broad as ESG. He thinks that will set Amberwave apart from those competitors in both value and performance.

“If you focus on everything, you’re almost by definition not going to be able to achieve market returns,” Katz said in a June 16 interview.

So far, iUSA has outperformed the S&P 500. Its top 10 holdings include Microsoft, Verizon, Visa, Amazon, and Walmart.

Amberwave sent a comment letter to the SEC objecting to its climate disclosure proposal.

Katz argues that premature standardization, or apparent standardization, of ESG-related metrics will stifle innovation.

He and his partners also maintain that the rules will favor ESG over other impact investing strategies, furthering what they see as a pattern of pro-ESG rhetoric and actions from the SEC.

Their letter noted a pro-ESG Tweet sent from SEC’s account on Earth Day 2021: “Environmental, social, and governance (ESG) Funds can provide you with the opportunity to put your money to work with companies that work on making the world a better place.”

Katz argues that the SEC’s recent emphasis on ESG and climate may obscure more pressing issues for investors. He cited the resilience of firms’ supply chains, a key factor that investors might find hard to assess given the lack of relevant disclosure requirements from the SEC.

“The capital markets are out of whack because there’s too much focus on these ESG-oriented priorities and not enough focus on other stakeholder priorities that are important for American communities,” he said.

Although Katz questions ESG, he defends the concept of stakeholder capitalism, often considered part of the impetus for the ESG movement.

He told The Epoch Times that stakeholder capitalism, properly understood, is much closer to the reality of how business works than the shareholder capitalism defended by Milton Friedman in his influential 1970 essay for The New York Times, “The Social Responsibility of Business Is to Increase Its Profits.”

“If you don’t have productive workers who want to be with your firm, and if you don’t have good relationships with the communities in which you do business, it will be very difficult for you to succeed for shareholders,” Katz said.

Katz also pointed out that non-ESG impact investing has a long history.

For decades, faith-based funds have enabled people to live out their beliefs through their investments.

Of course, plunking money in ESG alternatives isn’t the only means for opponents of the current movement to strike back.

Heritage’s Ray and Constrained Capital’s Neuman think that a GOP takeover of the House, the Senate, or both in November could thwart the SEC’s proposed climate disclosure rules or associated drivers of ESG from the government’s side.

Ray specifically cited riders to appropriations bills and, depending on how long finalization takes, a resolution of disapproval under the Congressional Review Act.

If Congress passes such a resolution and the president signs it, the SEC would be barred from enforcing that rule or any comparable rules.

“It would obviously lead to the demise of this rule and would stop similar disclosure-based regimes going forward,” he said.

In Ray’s view, uncertainty regarding future Congresses is just one example of why the SEC rules are unlikely to help investors assess any potential transition risks in the years and decades to come.

Simply put, the SEC cannot predict the future.

“It’s impossible to know what Congress or regulators are going to do even this year, let alone decades and decades from now,” he said.

ESG pioneer Dodson, a supporter of the SEC proposal, thinks that the SEC’s increased enforcement on ESG marks “a big difference in terms of the direction.”

“I think people that are sincere about it, and their investors, are going to want to make sure that their fund, if it’s called socially responsible—if it’s called ESG—that it truly is of that nature and is not just using it [ESG] as a marketing technique,” he said.

US SIF: The Forum for Sustainable and Responsible Investment declined to comment on individual investment products.

Deutsche Bank, Bank of New York Mellon, S&P Global, Mondelez, and the SEC didn’t respond to requests for comment by press time.

Nathan Worcester is an environmental reporter at The Epoch Times. He can be reached at nathan.worcester@epochtimes.us. Follow Nathan on Twitter @nnworcester