Wishful Thinking on ESG

In his Wall Street Journal column “A Solution Is in Sight for the ESG Controversy,” Vivek Ramaswamy proposes “disclosure to and consent from capital owners” as the solution to the infiltration of environmental, social, and governance (ESG) objectives into asset management. While his proposal may be elegant in theory, it would prove ineffective in several regards in the actual investment world.

The problem, according to Ramaswamy, is that large asset managers (BlackRock, State Street, and Vanguard) use such ESG factors in determining the capital allocation of their investment funds. Such practices violate their duties as fiduciaries and trustees fulfilling the “sole interest rule” to discharge their responsibilities solely for the benefit of their investors. Asset managers offer dedicated ESG funds, but more surreptitiously, integrate ESG principles into all their funds through proxy voting and “shareholders engagement.” Their political and social agenda permeates all their strategies and extends to the underlying invested companies.

As a solution, Ramaswamy proposes a requirement that investment advisers and pension funds inform their clients (the actual investors in the asset manager funds) “whether their money is invested in an ESG-promoting fund and provide express consent to do so.” This ability to say yes or no, he argues, would stop their investments from advancing an agenda they do not support and end the ESG debate in the asset-management industry.

This is wishful thinking—and here are four clear reasons why.

First, the proponents of ESG are masterful at manipulating language and misdirection. Imposing such a requirement would drive them to modify their disclosures and descriptions of investment strategies to satisfy the “sole interest rule” standard while still advancing their ”nonpecuniary interests or social causes.” Let go of the expectation that they would be honest in saying what they are attempting to accomplish. They would provide just enough transparency to satisfy the standard, but nothing more. ESG is a malleable concept and not a strict definition. The asset managers can describe it to mean whatever they want.

The asset managers will further conflate financial considerations with social or political objectives, deftly crafting their language so that a court would reject a claim they are not maximizing shareholder value. ESG is merely the current descriptor in a long history of investing for political and social ends (Socially Responsible Investing, Impact Investing, Stakeholder Capitalism, etc.) and it will not be the last.

Second, the author fails to recognize that many investors (“capital owners”) provide discretion to their investment advisers to make decisions for their investment management. The advisers may or may not vote proxies on behalf of their clients, but these clients have demonstrated trust in them and a lack of desire for this responsibility. They hired a professional so as not to have to worry about such matters.

Most investors want to set their portfolios and trust their advisers. Likewise, pension fund participants trust that their retirement assets are properly managed. They do not want to spend their time evaluating investment strategies and disclosures. I suspect very few are as politically and financially astute as Ramaswamy.

Third, the investor who does not agree with an ESG practice may not actually be that interested in altering their portfolio. They may even rant and rave about the current state of our politics, economy, and financial industry, but will not move a dime when offered a different way to invest their money. Hypocritical and contradictory, yes, but this is a reality to those who are familiar with this audience.

A better path forward than trying to regulate ESG proponents is to build an alliance of outstanding financial advisers, asset managers, and companies that fulfill their fiduciary duty to investors and reject a divisive and destructive ESG agenda.

Complacency, not objectionable politics overtaking the investment world, is the obstacle here. The investor may disapprove of ESG, but it does not negatively affect them in an immediate, concrete manner. The average investor is “fine” with their portfolio and adviser. An ideologically-aligned, non-ESG portfolio is a nice-to-have preference, not a necessity. Granted, the options to invest in a different manner are more limited, and the investor and adviser may simply lack awareness of their existence.

In addition, Ramaswamy’s proposal requires a significant commitment from the investor. Saying yes or no on the disclosure regarding investment funds demands time and thought. The large volume and complexity of information required to make informed decisions on the dozens of positions held in a diversified portfolio would be overwhelming.

Fourth and finally, and possibly most importantly, the ESG mandate has grown so pervasive that it is challenging to avoid in any portfolio. The large asset managers drive the underlying corporations to adhere to their ESG objectives, sometimes overtly but often covertly. Some may eagerly follow (e.g., Disney or Google) while the rest feel coerced to comply. Companies are compelled to spend precious limited resources on climate impact reports and diversity, equity, and inclusion (DEI) programs that do nothing to advance their companies’ mission to improve shareholder value.

Yet another regulation is not the answer. Cloaking their ESG principles in vague or neutral-sounding disclosures would in effect provide a cover of permission for the asset managers. Since our securities regulatory regime is disclosure based, they would be in the clear from a legal and regulatory liability perspective. Additionally, the cost to implement and enforce such a regulation would be borne by the investor, not the asset managers, as all regulatory requirements are.

Further, exactly what regulator does Mr. Ramaswamy expect to impose such a rule? The Securities and Exchange Commission (SEC) as currently composed is in concurrence with the ESG agenda. The Commission is more likely to enact rules facilitating these objectives rather than restricting them. Perhaps the states’ securities regulators can make headway with pension funds and state-registered investment advisers, but their reach is much shorter than the federal SEC.

If an investor does not agree with ESG, what other options do they have? A better path forward than trying to regulate ESG proponents is to build an alliance of outstanding financial advisers, asset managers, and companies that fulfill their fiduciary duty to investors and reject a divisive and destructive ESG agenda.

If ESG is a problem, this problem is not necessarily due to the large asset managers, but to those of us not creating better investment options. I respect and admire Vivek Ramaswamy for his professional accomplishments, especially launching Strive Asset Management (in which I am an investor). At the same time, I would argue that his diagnosis of the challenges must be cured not by silver-bullet regulations, but by the intentional building of solutions that advance beyond the current policy debate.