A Bump in the Road for ESG?

Navigating political ESG risk has jumped to the top of the spring 2023 agenda for US institutional investors and the asset managers and consultants they partner.

‘ESG integration’ - the idea that factors such as physical and transition climate risk and governance should form a key part of investment research - is not new.

But those three letters, E, S and G, are increasingly attracting the attention of legislators in the US. Texas, Florida and Kentucky are among the states that see them both as an attack on industries in their regions - particularly energy companies - and a convenient political football.

There is increasing fear among pension staff in ‘red’ states that well-publicized attacks on ESG could trigger rules that get in the way of their fiduciary duties to pension plan beneficiaries. Yet these same duties are often used as an argument by those opposed to ESG investing.

And while cries of “boycott the boycotters” ring out from these states, dramatic divestment proposals from ‘blue’ states are also worrying those charged with providing benefits to a large swathe of the nation.

Social duty

Investors are split on what new legislation might mean for their overall investing strategy and returns.

There are some carve outs to allow pension providers to continue to take account of factors they consider material, potentially leaving the door open for ESG to be considered. There is also debate on how to interpret new legislation relating to “pecuniary factors” in states such as Florida.

In Kentucky, pension trustees recently wrote to state officials to say they could not comply with new anti-ESG laws they believe will breach their fiduciary duties. And at a recent West Virginia Investment Management Board meeting a trustee declared, “there is nobody more anti-woke than me,” before joining the CIO and other trustees to complain about costs and other issues associated with new anti-ESG legislation.

To help defuse tensions, investors are focusing on how they are supporting oil and gas companies in transition to access new revenue opportunities and provide local jobs and profits, rather than just dumping stock.

For the vast majority of investors, engagement wins over divestment nearly every time, helping to improve returns and to enact the huge changes required across industries to meet climate goals.

But here there are growing frustrations that policymakers in ‘blue’ states are pushing measures that will have unintended consequences.

Investors worry that forced divestments or investing bans will be costly for beneficiaries and environmentally harmful if polluting companies are driven to less transparent private markets, or toward LPs who are less motivated by climate goals. Californian pension giant CalSTRS has recently come out in opposition of new bans on fossil fuel investing.

Risk and opportunity

While ‘ESG’ might be causing all kinds of new investor headaches, companies and infrastructure associated with energy transition are now one of the hottest areas for new allocations

Fueled by the recently passed US Inflation Reduction Act, which could see $4trn of new energy investment by 2032, and a big increase in venture and private equity capital targeting areas such as climate-tech, US institutional investors have been steadily putting more money to work on energy transition opportunities across their portfolios.

The increasing popularity of energy transition suggests pensions and other institutions can help position ESG and sustainable investing in a way that keeps the politicians at bay. Political risk, however, will remain something investors will want to factor into decision making.

Paul McMillan, editor-in-chief, With Intelligence

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