Investing that considers environmental, social, and governance (ESG) factors suffered a series of setbacks in 2022 — including fresh debate on what ESG is and a growing backlash against the practice.
Major banks and asset managers like BlackRock (BLK) — which had become vocal proponents of ESG-fueled stakeholder capitalism while continuing to invest in fossil fuels — faced accusations of "greenwashing" while also seeing more than a dozen U.S. states move to block them from government contracts amid conservative criticism.
And while the crusade against ESG shows no signs of letting up, particularly with a Republican majority in the House, one portfolio manager believes that ESG will survive the culture wars.
"[The backlash] is basically, frankly, a political ploy funded by… a network of dark money funders that is seeking to kind of make ESG or values-aligned investing a political wedge issue," Bill Davis, founding partner and portfolio manager at Stance Capital, an investment firm that focuses on ESG, told Yahoo Finance Live (video above). "I think it's doomed to fail for a variety of reasons."
One reason the backlash may not stick, according to Davis, is that even though engagement with ESG has exploded in recent years, it's still a relatively niche topic for most Americans.
A 2021 Gallup poll found that 64% of respondents were unfamiliar with the term "ESG" and just 8% were "very familiar" with the term.
"Interestingly, most Americans don't have any idea what ESG is," Davis said. "I think that you're going to find that, number one, the more talk there is, the more confusion there is; and secondly, the more people do get to understand what's actually going on, the more they're going to want to sign up for it. So I don't actually think that the political headwinds are going to amount to much, other than just simply a lot of noise."
Consumer demand for more sustainable practices will also play a role in fending off anti-ESG headwinds, Davis said, as will the demand from young talent.
“These employees are also consumers, and what they want is they want sustainability," Davis said. “So this idea that companies are being led around by the BlackRocks of the world is really completely missing the point that out of enlightened self-interest, many major corporations have recognized that this is really good for business.”
However, even if the trend of ESG adoption continues, asset managers still face another set of headwinds — this time from the markets themselves.
Last year, the premise that investors reap better returns by using an ESG risk analysis approach came under scrutiny as the war in Ukraine and a bear market in stocks weighed on performance.
ESG funds saw outflows for the first time in five years in the second quarter of 2022, though flows into sustainable funds rebounded in the third quarter. And for the full year, Morningstar reported that ESG investing garnered similar returns to the overall market.
Davis acknowledged that some of these difficulties are "self-inflicted" — namely. that as the Fed continues to raise interest rates, growth stocks have fallen somewhat out of favor.
"If you think about the S&P 500, it's a market cap-weighted index," Davis explained. "But because it's mega-cap concentrated and because you had stocks like Apple down… it's not surprising to see a lot of U.S. ESG managers, who happen to be growth-oriented, taking a big hit because they're simply overweight a sector of the economy that disproportionately underperformed in 2022."
Despite the challenges ahead for the industry, Davis contended that the argument for more ESG still holds.
"I don't think it's a hard sell at all," he said.
—
Grace is a senior editor for Yahoo Finance.
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