What is ESG investing (and why are Republican politicos mad at it)?

ESG is a capitalist hat trick and the latest Republican bogeyman. Here’s a primer on ESG investing and why it'll be a talking point in 2024.

It looks like we’re going to be hearing a lot about what’s known as ESG investing soon, so let’s get some context around capitalism’s latest obsession.

I’ve been rolling my eyes at ESG investing for years because of its limp attempt at compassionate capitalism. I’d written it off as a waste of words with all we have to talk about in financial media.

But now Republicans have twisted ESG into a political talking point, and I can’t leave it up to them to be your source of information on this topic.

What is ESG investing?

ESG stands for “environmental, social, governance.” The clunky acronym describes an investment strategy that accounts for not only a company’s financial performance but also the impact of its actions on the environment, the communities it touches and how it’s run internally.

Tons of investment firms have added ESG funds to their rosters. These are mutual funds or exchange-traded funds (ETFs), which means they’re baskets of securities from a variety of companies. Investors buy a portion of the fund instead of individual company stocks. Firms set parameters for the securities that make it into an ESG fund, often with a narrow focus like gender diversity, or excluding companies that peddle in tobacco, fossil fuels or firearms.

The purpose of this strategy depends on your priorities.

We’ve been framing it for years in the personal finance space as a way for millennials to get into the stock market while ensuring our money doesn’t support companies that contribute heavily to the climate crisis, exploit vulnerable workers around the world, or perpetuate racism and sexism through biased hiring and promotions.

Investment firms that manage ESG funds — like BlackRock, which has born the brunt of recent Republican backlash — tout ESG criteria as vital data points to understand how a company will perform financially in the future. Firms often claim the strategy has the potential to earn higher returns than traditional strategies that rely solely on financial analysis.

Why progressives don’t like ESG

My eye-rolling over ESG investing is for the same reason many anti-capitalists and progressives critique the strategy: It’s just a label.

The parameters for ESG investing aren’t standardized or regulated; they’re set for individual funds by the individual firms that manage them. As an investor, you can look into the criteria for a particular ESG fund, but there’s no government body overseeing what can and can’t be included. An investment advisor’s only regulated responsibility is as a fiduciary — ensuring it manages your money and advises you in your best financial interest.

Translation: Their job is to try to make you money.

A small hitch: Millennials started to question the ethics of investing in a big way a few years back (once we finally started earning enough to think about it). And Gen Z has their whole “worried about climate change cutting their future short” vibe.

So investment advisors need a way to attract the next generations of investors. A veneer of social responsibility makes investing palatable for young investors who want to make money without feeling guilty.

But as long as the ethical guidelines for ESG funds remain ad hoc and profit remains the priority for both fund managers and investors, the “ESG” label doesn’t carry much weight.

We’ve seen corporations make this move over and over again for decades — pasting Certified Organic labels on factory-farmed food, rainbow-washing their social media accounts every June and launching underfunded DEI initiatives in the summer of 2020. It’s just marketing.

ESG is how investment advisors play this game.

Why Republicans don’t like ESG

Despite the lack of actual teeth in ESG strategies, Republicans have dug up this trend as the latest liberal bogeyman coming for America.

At last year’s States and Nation Policy Summit, the annual conference where Republican operatives cook up the policies that seem to serendipitously pop up in state legislatures around the country, one speaker called ESG investing “the greatest threat to American democracy since the Civil War.” That’s according to Wisconsin Assembly Reps. Kristina Shelton and Francesca Hong, who braved the conference to learn what their constituents could expect coming down the pike from our Republican-controlled legislature.

“Just as with CRT [critical race theory], the right is using a complex and niche topic to concoct new threats out of thin air in order to divide us so we cannot all fight together for economic security for everyone,” Shelton and Hong wrote in an op-ed for The Cap Times.

Republican politicians including Florida Gov. Ron DeSantis, former Vice President Mike Pence and Texas Gov. Greg Abbott have decried ESG investing as a threat to free market capitalism, encouraging states to divest public pensions and other financial engagement from institutions that use ESG criteria in some funds.

Shelton and Hong reported, “In an email from just last month, [The] Heritage [Foundation] whined that ‘the Environmental, Social, and Governance (ESG) movement is a dangerous attempt to undermine our market and force a woke agenda on all of us.’”

So. That’s a lot.

The basic argument, for now, is that incorporating ESG criteria into investing decisions instead of relying solely on financial analysis puts social responsibility ahead of gains, which could mean less money for investors.

A few counterpoints…

First, if it isn’t already obvious: I’m in favor of putting environmental, social and governance ethics ahead of capital gains, and it would be great if investment strategies actually did that. Any argument that profit is more important than people or the planet is gross.

Second, you could argue, as Republicans are, that a lack of focus on profit means less money for “working people” — in the form of lower returns in pensions and other retirement accounts. But they’re presenting false empathy. 89% of wealth in the stock market is owned by just 10% of investors, so reduced gains (if they were real) stand to impact the wealthiest Americans much more than the working class.

Third, there’s no evidence that ESG funds do yield lower returns. Lots of studies see higher returns from funds that use ESG criteria, and some have questioned those results, according to ABC News. There’s no consistent trend of lower returns.

Prepare for ESG debates in 2024

I’m annoyed to be in the position to sort of defend ESGs. They’re not the shortcut to ethical investing capitalists want us to believe they are. But they’re absolutely not comparable to, um, the Civil War?!

I wouldn’t recommend investing in ESG funds, because I don’t recommend investing in any managed funds. Studies show index funds are the best route to stable gains — if you’re going to invest in the stock market at all. I don’t believe there’s a true route to ethical investing in public companies in the first place. But our society makes it pretty difficult to experience comfort in retirement if you forgo this option, so you have to find your own line.

However, I would never recommend or support banning the use of ESG criteria in investments, as DeSantis has proposed in Florida. I wouldn’t suggest pulling state pensions from institutions that use ESG criteria, as Abbott has done in Texas, to the tune of at least $300 million in additional costs for the state.

If Republicans wanted to make a real argument against ESGs, they could critique investment advisors for trying to dupe consumers by greenwashing corporate practices with a tidy label. They could shame corporations for consistently putting shareholder profits above human rights and environmental sustainability for decades. They could propose actual regulation to standardize the criteria for so-called ethical investments and hold fund managers accountable to them.

But, of course, accountability for capitalists has never been the goal.

I don’t know why Republican tastemakers have settled on this particular bogeyman. Maybe their corporate supporters are afraid of losing money if we all choose ethics over profits. Or maybe, like CRT, plucking ESG out of a pot of trending topics is a way to wear the mantle of fighting the “liberal agenda” while doing what the Republican party truly wants to do in every instance: nothing.

But the reason doesn’t matter. If decrying ESGs riles up the base, conservative figures will find reasons to decry them. Steel yourself for more of this debate in 2024 by understanding what this strategy actually means for investors (and retirement funds) and thinking critically now about the criteria you want steering your investment decisions.

And please pass this on to a friend so they can do the same. Don’t let fantastical conservative talking points or investment advisors’ greenwashing control this conversation.