Environmental, social and governance (ESG) metrics in the US have never been as established as they are within Europe.
From a performance perspective, research by Investment Metrics last year found high-ESG European stocks outperformed much more often than high-ESG US stocks did. In fact, high-ESG US stocks did not outperform the general market.
Confluence managing director – performance, risk and analytics Damian Handzy explains that the difference may reside in investor sentiment and demand. While European investors have shown receptiveness to ESG issues, their US counterparts are more reserved.
It will be interesting to see if these high-profile Republican states are followed by other politicians
Handzy says: “In America it’s a controversial topic, but in Europe it is not.
“That stark difference in general populace sentiment is echoed in the stark difference in ESG performance between the two continents.”
‘Pecuniary factors’
ESG is controversial not only among investors. It has also become a political battleground.
Recently, the state of Florida passed a resolution that banned pension funds from taking ESG metrics into consideration in their investment process. Instead, the resolution states, investment decisions must be based only on “pecuniary factors”.
Florida governor Ron DeSantis said: “With the resolution we passed, the tax dollars and proxy votes of the people of Florida will no longer be commandeered by Wall Street financial firms and used to implement policies through the board room that Floridians reject at the ballot box.
‘ESG investment’ has become a catch-all term that means different things to different people and unfortunately has become political for some
“We are reasserting the authority of Republican governance over corporate dominance and we are prioritising the financial security of the people of Florida over whimsical notions of a utopian tomorrow.”
The state of Texas passed a law in 2021 that restricted to the state, localities and pension boards any dealings with financial firms looking to divest from the fossil-fuel industry. This summer the Lone Star state published a list of 10 financial groups that were “boycotting” the fossil-fuel industry, via its comptroller, Glenn Hegar.
“The ESG movement has produced an opaque and perverse system in which some financial companies no longer make decisions in the best interest of their shareholders or their clients,” said Hegar.
Other Republican states have enacted similar resolutions, such as Idaho, Oklahoma and West Virginia.
Mid-term elections
Foster Denovo head of investment research Declan McAndrew says: “With US mid-term elections in November, political rhetoric and headline-grabbing policy announcements are heightened. These elections are seen as crucial for setting out the context and composition for the 2024 presidential contest.
The current approach in the US towards ESG investing is based around offering financial incentives
“While decisions of this nature are disappointing and short-sighted, we should be careful not to over-react to them. Their negative influence could be limited; indeed, it may galvanise others to make their stance clearer.
“We have seen an increase in the political divide around ESG investing, particularly with the energy and inflation shocks we are all currently experiencing. This is not just in the US but also potentially in the UK.”
The US commitment to sustainability has been inconsistent. The country rejoined the Paris Agreement on 20 January 2021 after withdrawing in November 2020. With this precedent, ESG investors may question the reliability of US participation in the transition to a sustainable economy.
On the eve of the mid-term elections and two years from the presidential election, the federal stance on ESG could change.
If the term ‘ESG’ disappears tomorrow, the fundamental questions will remain
“This will depend on whether Congress is split between the two houses and also on whether Donald Trump or a similar hardliner gets elected once again,” says Victory Hill Capital Group chief executive officer Anthony Catachanas.
Yet the structure of the US political system means each state defines its own policies, independently from the federal government.
While the attitude to ESG varies between states, hostility to the metrics is specific to red states.
Handzy says: “Although certain states are limiting and even prohibiting ESG-based investment, other states are encouraging ESG, but not necessarily making this a legal requirement.
“New York State’s pension system has promised to divest from companies whose main business contributes to global carbon emissions, but this is not required by law.
The stark difference in general populace sentiment is echoed in the stark difference in ESG performance between the two continents
“In 2015, California passed a law to remove public investments in thermal coal. In early 2022, it passed the first law in the US requiring large companies to disclose all their greenhouse gas emissions.
“Demand for ESG investing is largely coming from individual investors and even certain cities. For example, in late 2021, San Francisco’s City & County Employees’ Retirement System changed its $636m [£548m] passive domestic large-cap value equity portfolio, managed by BlackRock, to an active systematic equity strategy incorporating ESG considerations, also managed by BlackRock.”
Anti-ESG impact on Europe?
Due to US global influence, one may wonder if the political division on ESG will be imported to Europe.
Catachanas thinks this unlikely, although he doubts Europe will influence the US either.
He says: “Europe is far ahead of the curve on ESG investing. These notions and principles are viewed as financially and economically beneficial in portfolios these days, and continue to become increasingly the norm.
We have seen an increase in the political divide around ESG investing – not just in the US but also potentially in the UK
“The disclosure regimes that have emanated out of Europe in general are very focused on a local European reality (think the EU taxonomy). They usually do not export very well to other parts of the world.
“It is highly unlikely to affect European investors and their orientation, but vice versa as well.”
The anti-ESG spate remains localised within the US and does not reflect its federal policies.
Handzy says: “The US, on a federal level, is not opposed to ESG investing. The recently passed Inflation Reduction Act makes provision for clean energy production, investments into natural capital, and tax credits aimed at reducing carbon emissions.
The ESG movement has produced an opaque and perverse system in which some financial companies no longer make decisions in the best interest of their shareholders or clients
“The current approach in the US towards ESG investing is based around offering financial incentives for environmental business practices. Although this may not be as powerful a motivator as the European approach, it squarely brings the US into the ESG fold.”
But McAndrew believes political imperatives could still prompt anti-ESG rhetoric in Europe.
“It will be interesting to see if the moves by these high-profile Republican states are followed by other politicians seeking a more polarised view of ESG, which may appeal to their core election base at an opportune time,” he says.
“In the UK we have a new prime minister, and her highest priorities are immediate and pressing rather than long-term thinking. Will this influence policy? We’ll find out in due course”
Stewart Investors senior investment specialist Pablo Berrutti believes terms like “ESG” can distract from the underlying issues which are genuine concerns for investors and businesses.
In the US it’s a controversial topic, but in Europe it is not
“‘ESG investment’ has become a catch-all term that means different things to different people and unfortunately has become political for some,” says Berrutti.
“We need to think about either whether certain issues remain relevant to society and therefore businesses and investors, or whether individual companies make great investments because they offer solutions to problems and do it with integrity. No country can avoid those discussions because they are core to what drives value from the bottom up.
“If the term ‘ESG’ disappears tomorrow, those fundamental questions will remain.”
This article featured in the October 2022 edition of MM. If you would like to subscribe to the monthly magazine, please click here.
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