One of the largest investing trends in the past decade has been the rise of ESG—that is, putting money behind companies that keep an eye on environmental, social, and corporate governance concerns along with profitability. Now there’s growing disillusionment with the idealistic framework, and in some sectors, a hostile backlash. Additionally, a wave of new laws threatens to impact businesses whose mission explicitly includes things like reducing their carbon output or increasing diversity in hiring.
What’s behind the shift? One factor appears to be the relatively weak performance of ESG investments, which are increasingly popular with large investors such as state pension funds, attracting $70 billion in new assets in 2021—a record, according to data from Morningstar. ESG funds now account for about 10% of all assets invested.
But in the first half of 2022, funds with the highest Morningstar sustainability ratings also had the worst returns, losing 13% on average so far this year, compared to those with lower ESG ratings, which lost just 4%. What’s more, a recent analysis by Bloomberg found that global ESG funds have underperformed the broader market in the past five years. Critics of ESG funds—Elon Musk, among them—have raised doubts about whether ESGs measure the right things in meaningful ways, or are just a feel-good grift.
At the same time, regulators and ratings agencies have been pushing ESG into the spotlight. In March 2022, the Securities and Exchange Commission proposed rule changes that would require registrants to include climate-related disclosures in their registration statements and periodic reports. The same month, S&P Global Credit Ratings published an ESG “report card” for U.S. states and territories, which was not well received in red states, in particular.
Lawmakers who already disliked ESG’s whiff of wokeness have pushed back. In April, the treasurer, attorney general, and congressional and legislative leaders of Utah wrote to S&P to demand it withdraw the new ESG scores. (The state, which has an AAA credit rating overall, received a “moderately negative” environmental score and “neutral” social and governance scores.) The attorney general of Missouri is leading a multistate investigation into the ratings.
Eighteen other states have joined another Missouri-led investigation into Morningstar Inc. and its wholly owned subsidiary Sustainalytics over the ESG ratings. (Morningstar’s founder and executive chairman Joe Mansueto owns Fast Company’s parent company.) And in August, the attorneys general of 19 states, including Texas, Georgia, Arizona, Utah, and Ohio, sent a strongly worded letter to Larry Fink, CEO of BlackRock—the world’s largest money manager and a high-profile proponent of sustainable investing—attacking the firm’s reliance on ESG criteria in managing state pension funds. They accuse the firm of using “the hard-earned money of our states’ citizens to circumvent the best possible return on investment . . . [and] to pressure companies to comply with international agreements [that] force the phase-out of fossil fuels, increase energy prices, drive inflation, and weaken the national security of the United States.”
In September 2021, Texas implemented a ban on municipalities doing business with financial firms that eschew the fossil fuel and gun industries. In August 2022, Florida Governor Ron DeSantis approved a resolution that bars his state’s pension fund from considering ESG factors in making investment decisions, ordering them to “maximiz[e] financial return over and above other considerations.” Also in 2022, Arizona, Idaho, Kentucky, North Dakota, Ohio, Oklahoma, West Virginia, and Wyoming have all enacted similar legislation. Several more states have bills in the works. At least one, in Utah, has business leaders sounding the alarm.
