Understanding Environmental, Social and Governance investments

Twenty-five years ago, an acronym, SRI, became popular in investment circles. It stood for Socially Responsible Investing. There were firms that popped up who focused solely on these types of investments. There was one problem: The big push for their adoption hit during the tech bubble. You had tech stocks zooming up day after day, achieving results that were astronomical. SRI investments struggled – and failed – to even keep up the S&P 500. Most investors were simply not willing to accept a return that was 30% less than the return on the major indices. Except for the hardcore “values” investor, SRI’s cache faded away.

Out with SRI, in with ESG

Now there’s a new acronym, ESG, that is a variant to SRI. It stands for Environmental, Social and Governance. It is not a measurable asset class – it is a concept; it is a marketing term. It does not have a generally accepted definition similar to major asset classes. It is a term that is absent of academic rigor. And it has caught the attention of the U.S. Securities & Exchange Commission (SEC). It has become such a fad that I have even received email solicitations for software that will help us “tweak our portfolios” so that they appear more ESG friendly!

At our recent annual visit from our compliance Attorney, one of the first questions he asked was, “Are you using the term ‘ESG’ in any of your advice or marketing materials?” My answer was, “No, why?” He replied, “It is on the SEC’s radar. It’s one of those questions you don’t want to answer the wrong way during your next audit.” 

You see, the SEC gets very wary when American Consumers are wooed with marketing terms that have no clear meaning – no matter how well intended they sound. I’ve even heard from one client who told me that the marketing person for their foundation verbally represented to their Board that their ESG investments outperformed the major indices. The SEC would bury anyone who was naïve enough to put that in writing. Not only is that an unproven representation, but objective academic research would demonstrate the opposite.

While ESG isn’t having to compete with a tech bubble, today’s political and cultural environment presents its own challenges. The Attorneys General from nineteen states have written a letter to Blackrock regarding the ESG pressure it is alleged to be putting on the corporations in the investment funds it has created. They expressed concern that there is a political agenda that could harm the financial returns for the retirees in the public pension plans in their states. Politics aside, their efforts should bring greater clarity and measurement to any future ESG standard that may develop. 

While I don’t agree with their political agenda I do think their letter is bringing important scrutiny of ESG. They simply want to see ESG go away. To them ESG is merely a ploy to push the President’s agenda. Because they perceive that Blackrock CEO Larry Fink and White House economic policy chief Brian Deese, a former Blackrock Executive, have pushed ESG, in their eyes “it must be bad.” What I hope is that their letter causes a more careful analysis of ESG investments. 

Protecting investors

Maybe their efforts are working! On March 4^th, the SEC announced the creation of a 22-member task force to examine and develop standards for ESG-related disclosure and investment. The Climate and ESG Task Force will develop initiatives to proactively identify ESG-related misconduct.

“Proactively addressing emerging disclosure gaps that threaten investors and the market has always been core to the SEC’s mission,” said Acting Deputy Director of Enforcement Kelly L. Gibson, who will lead the task force. “This task force brings together a broad array of experience and expertise, which will allow us to better police the market, pursue misconduct, and protect investors.”

Personally, I would like to see ESG move from a marketing term to an actual standard. I consider it important that if you have certain beliefs and values that you want to see reflected in your investment portfolio, you can knowledgeably make that choice using standards that you can trust. As a fiduciary, that is important to me, as well.

Earlier this year I made a similar decision. For the past year I’ve been looking at electric cars. My interest has been more for the well-being of my grandchildren and those who follow than just for myself. With the Russian invasion of Ukraine, my motivation expanded. I didn’t want to continue to consume gasoline that benefited the Russian economy. A close friend had purchased a hybrid vehicle a year ago. After hearing how well it has worked for them, we made the same decision. It may not have been the most economical alternative, but it was a decision that fit with our beliefs and values.

I expect investing in ESG products will fall along those same lines. Once standards are in place, you will have clarity regarding what investing in ESG will cost you in your portfolio rate of return. I am hopeful that the Task Force can work promptly and get standards developed over the next two years.

The SEC wants to protect the public from dubious marketing claims. They aren’t for or against ESG. They simply want ascertainable standards in place when any such term is used. I’m hopeful that they develop a standard that allows you to knowingly invest your money in a way that is consistent with your beliefs and values. Stay tuned to see how this all plays out!

Rick Adkins, CFP®, ChFC, MBA

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