Are ESG ETFs a gimmick? The debate surrounding the transparency and social agendas of sustainable investing

ESG – environmental, social and governance – is one of the hottest trends in the investing world, but some investors are calling it a gimmick.

ESG is a new industry of funds launched by companies like BlackRock, Vanguard and Fidelity that are invested in companies that meet certain criteria. These ideals pertain to standards of diversity, equity and inclusion, pollution and carbon emissions, and data security, among others.

But attacks on ESGs have come from all over. New York City Comptroller Brad Lander recently sent a letter to BlackRock CEO Larry Fink demanding the company bolster its climate disclosures and publish a plan to establish a commitment to net-zero greenhouse gas emissions across its portfolio. 

Republican politicians, on the other hand, have accused BlackRock of boycotting energy stocks. On Wednesday, Louisiana announced it would pull $794 million out of BlackRock's funds, citing the firm's embrace of ESG investment strategies.

BlackRock did not immediately respond to a request for comment.

A recent New York Times op-ed by New York University Stern School of Business professor Hans Taparia said that, while ESG investment can create incentives for companies to be more socially and environmentally cautious, many investors falsely believe their portfolios are benefiting the world when ESG investing is designed mainly to maximize shareholder returns.

Nearly 90% of stocks in the S&P 500 are in an ESG fund that uses MSCI ratings.

The op-ed further argued that Wall Street needs more stringent rating systems, especially when companies that have received high ESG scores have been criticized for contributing to environmental or social issues.

Arne Noack, head of systematic investment solutions for the Americas at DWS, told Bob Pisani on CNBC's "ETF Edge" that ESG investing is "most definitely not a sham." He believes that the idea behind the strategy is that companies generate profits in healthy and sustainable ways.

"What ESG investing is, is very simply put, an incorporation of publicly available data into investment processes," Noack said. "None of this is done opaquely. All of this is done very transparently."

Small but controversial

Some investors like Noack have pointed out that debates surrounding ESG investing may be getting more attention than they deserve. ESG funds make up just 6% of exchange-traded funds by number and 1.5% by ETF assets. However, grouping all ESG funds into one classification is too wide-ranging, Todd Rosenbluth, head of research at VettaFi, said in the same segment.

Among large-cap ESG ETFs are the iShares ESG Aware MSCI USA ETF (ESGU), which tracks an index of companies with positive ESG characteristics. The SPDR S&P 500 ESG ETF (EFIV) tracks an index designed to select S&P 500 companies meeting ESG criteria, while the Xtrackers MSCI USA ESG Leaders Equity ETF (USSG) corresponds to the performance of its underlying index. And the Invesco Solar ETF (TAN) invests 90% of its total assets in an index of solar energy companies.

Noack said there is still plenty of room to improve upon ESG scores. The Xtrackers S&P 500 ESG ETF (SNPE), for instance, doesn't target the 25% worst S&P 500 companies from an ESG perspective of each industry group. This excludes companies that manufacture or invest in tobacco and controversial weapons.

But some investors believe these ESG funds are pushing a social agenda. Vivek Ramaswamy, executive chairman of Strive Asset Management, said in the same segment that his firm has pushed back against "woke capitalism" in part through two ETFs: the Strive U.S. Energy ETF (DRLL) and the Strive 500 ETF (STRV). He told Pisani that companies need more diverse perspectives and should leave politics to politicians.

Ramaswamy has focused on bringing attention to "green smuggling," the broader range of ETFs that are not marketed as ESG but use linked voting guidelines and shareholder engagement principles to engage with companies and vote their shares.

"If you're an owner of capital and you want, with your money, to tell companies to pursue environmental agendas or social agendas, it is a free country and you are certainly free to invest your money accordingly," Ramaswamy said.

"But the problem that I see is a different one," he continued. "Where large asset managers, including the Big Three, are using the money of everyday citizens to vote their shares and advocate for policies in corporate America's boardrooms that most of those owners of capital did not want to advance with their money.

ESG 'sleight of hand'

Leading figures in the stakeholder capitalism movement have argued that, because society gives benefits to corporations and shareholders like limited liability, corporations are obligated to take social interests into account. But recently, asset managers have started saying that many corporations are instead trying to maximize long-run value.

Rosenbluth asserted that there are no purely sustainable firms, so "the fact that we have an anti-ESG couple of firms out there is ironic because there is no ESG-only firm of any size and scale."

Ramaswamy said this claim was inaccurate, since firms are using ESG principles to vote all of their shares, even though just 2% of assets under management for firms like BlackRock are ESG funds.

"The heart of the problem, in my opinion, is that it's not just the 2% but the 100% that lives by this firm-wide commitment that some clients demanded but other clients didn't necessarily want," Ramaswamy said.

He cited examples of Chevron's Scope 3 emissions reduction proposal and the racial equity audit at Apple, both of which carried majority shareholder support, that used capital of all funds they manage.

"I have a problem with using the money of somebody else who invested in funds, with the expectation that the person who's voting those shares is only going to take pecuniary interest into account, actually taking these other social factors into account instead," Ramaswamy said. "That's the sleight of hand."

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