November 13, 2023 • 30 mins
Dr. Dan Sutter, of the Manuel Johnson Center for Political Economy, hosts EconVersations, a program that explores the role of free markets in promoting prosperity through conversations with Manuel Johnson Center faculty and guests. In this episode, Dr. Sutter interviews Dr. Allen Mendenhall, as they discuss whether ESG investing is good for the economy.
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(00:01):
The opinions expressedon this program represent
the viewpoints of individualauthors or contributors,
and do not necessarily reflectthose of Troy University.
This is E Conversations,
a joint production of Joy TrojanVision and the Manual. A.H.
Johnson Centerfor Political Economy.
(00:22):
Now here's your host, Dr.
Dan Sutter.
Helloand welcome to Conversations.
I'm your host, Dr.
Dan Sutter of the Johnson Centerfor Political Economy on Wall
Street has long servedas the embodiment of greed
in our economy, representedperhaps most visibly
and memorably,
by the character GordonGekko in Oliver Stone's movie.
(00:43):
Many have long calledfor investors
to consider the good for society
as opposed to their own profitsin investing their money.
The ESG movement is a modernversion of socially responsible
investing, embodying
this idea that of consideringsocietal impact.
Perhaps ironically, financeis attempts to change the world
instead of making moneyhave proven
(01:03):
even more controversialthan greed ever arise.
How is an investmentstrategy managed to become
a contentious political issue,
even being discussedby presidential candidates?
And is ESGtruly a threat to a prosperous
and thriving market economy?
Joining me in conversationstoday to discuss ESG is Dr.
Element at Hall.
He's the Grady Rogier professor
(01:24):
and executive director
of the Johnson Centerhere at Troy University.
Dr. Mendenhall has a bachelor'sdegree from Furman University,
a law degree and master'sdegrees
from West Virginia Universityand a Ph.D.
in English from Auburn.
Prior to joining Troy, Dr.
Martin Hall
worked in the AlabamaSupreme Court, and he was also
the director of the Blackstoneand Burke Center
(01:44):
at FaulknerUniversity's Law School.
Welcome back to the show, Alan.
Dan Thanks for having meas always.
I am always
very happy to be hereand very grateful to you
for having so many episodesand being a tireless
defender of market education.
Well, well, thanks.
Thanks so much.
And we'll have you on more times
(02:05):
giving your opinion of our host.
So before we get started, just
explain for our viewerswhat exactly ESG is.
I use the initials there,but they have the
they are an initials.
So explain for everybody
before we get started hereexactly what ESG is.
So ESG isthe acronym that stands
(02:26):
for environmental,Social and Governance.
And that acronym involvesthe financial non-free
natural factors and metricsthat central banks,
institutional investors,investors in general,
all sorts of financialinstitutions take into account
when they allocate capitalor assess risk.
(02:48):
So we're principally talkingabout investment criteria.
When people say we're goingto invest in ESG funds.
What they typicallyare referring to are,
more than anything else,
mutual fundsand exchange traded funds.
So a mutual fund is differentfrom an exchange traded
fund in thatthey both pool securities,
(03:09):
but a mutual fund is tradedonce a day.
The value of it is calculatedat the end of the day,
whereas an exchange traded fund
can be boughtand sold all throughout the day.
Mutual funds
are typically activelymanaged by a manager.
You pay fees,
whereas an exchange traded fund
is a passive investment vehicle,and an exchange traded fund
(03:31):
will typically track
an indexsomething like the S&P 500.
And therefore, as a passiveinvestment vehicle, it
typically outperforms the marketbecause you're not dealing
with human intelligence.
Tell it.
It's having to pick this company
or that company or this fieldor that field.
(03:51):
Mutual funds are much olderETFs are
a moreof a newer form of investment,
but they are typicallywhere we see
ESG investments occurring.
So explain a little bit like soU.S., ESG, environmental,
socialand governance components.
What would be some of the thingsthat would fit
(04:11):
under those headings? Yes.
So under the EA, for example,
you might have companiesincluded within an E
if they have committedto net zero emissions by 2050,
all sortsof environmental factors,
whether they are pertainingto biodiversity
or just in general pollutionor other initiatives
(04:33):
that those companiesmight undertake that are green.
The s would refer to socialand that can be
a wide variety of things.
I think in Europe
the social tends to involvemore workers, right?
Right.
Whereas inthe United States, the social
tends toward,
you know, diversity, equity,inclusion in the workplace
(04:56):
or commitmentsto different social causes,
whether companies are investingmoney in Black Lives Matter or
of one onesort of controversial area
in which we're seeingit is after the Dobbs
opinion is whether a companywill pay for employees
to go across the state to getan abortion in another state
where abortion is legal.
(05:18):
So these all are factorsthat fall into the. Yes,
the the G refers to governance,as you mentioned earlier.
And this is sort of boardlevel diversity
or executive compensation,those types of matters.
But I actually like to think ofthe G in the bigger picture
in terms of the shiftfrom the shareholder
to the stakeholdermodel of governments.
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The traditional Milton Friedmanline that corporations exist
for the maximization of profitsfalls under the traditional
shareholder model,whereas the stakeholder model
is different, the stakeholdersthat are obvious would be
customers, would be employees,would be suppliers,
but stakeholders are broadlydefined these days to be society
(06:03):
writ largeor even the environment
categories that are so broadthat they're almost undefinable.
Right.
And that is the shiftthat we're principally seeing
in this ESG trend.
And then the explicit ideawould be to use your money
to advance these causesas opposed to trying to
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make money for yourselfor make the most money you can
or make whatever return you wantwith a degree of safety.
So is really explicitlynot trying to do what
to maximize your own return,but rather to try to
advance these causesthrough your actions
or through your investments,right?
That's right.
And so there are sort oftwo sides to that.
(06:46):
The first sideis on the investor side.
So people are investingin, let's say it's an ETF
that's ESG weighted well,they put their money in an ESG
portfolio to
to to try to realizesome returns in social values.
And that is perfectly okay.
And retail investoras a household investor,
as an individual,
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you can put your moneywherever you want to put it.
Where ESG becomesproblematic is where we have
in particular governmentmoney being invested.
So municipal bonds,pension money,
sovereign wealth funds,these are all invested
and they're invested byinstitutional investors that
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then take their
their profits and buy sharesof publicly traded companies
and then try to pushthose publicly traded companies
into some of this ESG space
where otherwise these companieswould not a participant of ESG.
Now they've got their
shareholders telling them, hey,you need to
(07:50):
move into this space on thisparticular issue or you need to
diversify your board,or we need to get rid of your,
you know, this committee chair,because this committee chair
doesn't represent a particularethnic group or,
you know, doesn'thave you don't have enough,
you know, diversityin terms of sexuality
(08:10):
on on on the boardand all kinds of things.
But these are all pressuresthat get exerted sort of
upon companies sometimes againstthe company's best interests.
And so whether it be
through investors or pressureon like, say, the Fortune 500
(08:30):
companies to change their waysis still sort of this idea
that these businesses needto pursue these changed society.
That's right.
As opposed to eithermaximizing their own profit.
If you're talking aboutlike Ford
or Exxon or investors
going out there tryingto allocate their money to
make the best returns,the biggest returns they can.
(08:51):
Well, that's absolutely right.And it's important
to realize how powerfulthese companies are.
So the big three are BlackRock,State Street and Vanguard,
and they together have around23 to $26 trillion of assets
under management.
That's larger than the entireUnited States GDP.
Well, there are just under
$100 trillion of assetsunder management globally.
(09:14):
Well, how in the worlddo you get to those figures
when you only have
a little over 300 billionairesin the United States
excuse me, 700,
a little over 700 billionairesin United States, a little over
3000 globally.
There's just not enough
private wealth in the worldto get to those astounding
figuresin the trillions of dollars.
So where do they come from?
I already mentioned it'sgovernment money.
The sovereign wealthfunds are big ones.
(09:36):
No, explain. Explain. Yeah.
Explain what a sovereign wealthfund is, because. Sure, sure.
Everybody'sgoing to know what that is.
Yeah, well, Sovereign Wealth
Fund is basically just a stateowned investment fund.
And so Norway is very oilrich country
and it has about$1,000,000,000,000
worth of assets under management
and it's its sovereignwealth fund.
China has.
(09:56):
And so like
what Norway's done there isthey've taken some of that
royalties or some of the moneythat would have come in
from their oil,their their oil development.
And they've put itin this savings,
in fact,a savings account, right?
That's right.And they've invested that money.
And so China has overa trillion United Arab Emirates
and Kuwait have somewhere arounda trillion each.
(10:19):
Hong Kong has about 500 billion.
Qatar has about 500 billion.
So these arethese are astronomical amounts
of of of government moneythat are getting invested.
And this is notwithstandingthe pension money
that gets invested,the top 100 pension
funds in the worldamount to around $18 trillion.
So now you're starting to seewhere the money comes from.
(10:42):
This is how the big three
have that much moneyunder management,
that many assetsunder management.
That's how globally we havealmost $100 trillion of assets
under managementis through these
thesethese government investments.
And I haven't even mentionedbonds among all those.
And the other thing
that's a sort of a newertrend is
these are all institutionalinvestors.
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So 100 years ago, you know,
most investors were justhousehold retail investors.
They were wealthy individuals.
They weren't thesebig institutional investors
In 1981, institutional investors
amounted to about 35% of ownersin the stock market.
That went to 58% in 2002.
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And now it's over 80%.
So the stock market isis become dominated
by these institutional investorsand not by just
wealthy individuals.
And and they're the onesthat manage
all this government money. Now.
They're other formsof private money.
Their insurance moneygets invested,
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endowments from foundations,those, you know,
university endowmentsthat are privately managed
those those thosemake it in there, too.
But these are all differentmechanisms
for how these asset managers
get so much moneyunder management.
There's this idea, though,that ESG is a privately driven
thing, and I really wouldchallenge that.
(12:07):
The interesting thing about ESGis it starts to blur
the distinctionbetween public and private.
So let'sjust take BlackRock as the big
so let's let's let's thinkabout this for a sec. Yeah.
So when you say privately
any investor today,just as any investor in the past
could, always
is free to invest their money
however they wantand if they want to,
(12:28):
you know,
for instance,
during the Vietnam War,some people wouldn't
want to invest in Dow Chemical.
They were making the napalmthat was being dropped
on villages
and people thought like, okay,even if that's profitable,
you'rethat's sort of like blood money.
You've got blood on your hands.
You're making money from makingthis product that's harmful.
And there's nothing you do.
To be clear,
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there'snothing wrong with investors
choosing to investonly in businesses
that even if they're legal,they think like,
that's not somethingI want to be part of.
That's not somethingI approve of. Absolutely.
And that could go on the leftor go on the right
if you are an investorand you don't want your money
going toward the firearmsindustry,
then don't put it there.
If you're an investorand you don't want
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your money going toto pornographic companies or,
you know, or whatever it is,alcohol, tobacco, you name it,
that's fine.
You can invest your moneyto maximize social value
if that's what you want to do.
You can also hire a moneymanager.
You can hire an asset management
asset manager to investyour money in those ways.
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If you put controls on
how your investment is,and that's perfectly fine.
Where the problem is iswhen asset
managers are investinggovernment money,
you think about where all thatgovernment money comes from.
It comes from all these peoplewho really lack agency
in determining howthat money gets invested because
they're investing for
on behalf of,let's say, just as he's doing
example, let's sayit's the state of Alabama.
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Well, the state of Alabamabecomes the client,
notwithstanding the maybe,you know, thousands
and thousands of people
whose moneyis contributing to that fund.
And so then you have a situationwhere these individuals
whose money has becomegovernment money through
pension tax, whatever it is now,they don't get to choose
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where the money that that
that they earned in thatthey gave to their government.
Now the government's investing.
They have no agencyin determining where
wherethat money is getting invested.
So when that happens,
the investor is actingas a fiduciary.
And for for all thesepurportedly numerous
beneficiaries.
And the problem comes
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when those investmentsare not based
on the maximizationof financial value, because now
you're investing on perceivedsocial value,
there's no wayto actually assess that.
Like what are what arethe people of Alabama want?
What does Joe want, Larry want?
And all these people,
you can't determine what theywant in terms of social value,
but it's clear that they wantreturns on financial investment.
(14:58):
That's an obvious thing, right?Yeah.
With the pension,one thing you can clearly say,
you know, obviously you don'tsimply have enough money
taken out of your payto pay the benefits.
The expected is that that moneyis going to be invested
and it's going to earn returns.
And then it's
not just what you saved,but the the primarily
(15:19):
the earnings on those returns,
especially if you start young
in your twentiestrying to save from that.
There's like 40 yearsfor that compound interest
or the compounding returns toto build up a lot of money.
So clearly people have it withthey're counting on that money.
Earning a returnis sufficient to return to
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fund their retirement.
So that's exactly right.
And just to add to that,I mean, ESG
violates a fundamentalprinciple of investment.
I mean, the traditional wisdombehind investment was that
you were doing two things
mitigatingrisk and maximizing returns.
And that requireddiversification,
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diversification acrossfields, across industries.
Because if there's a downturnin one area,
well, there might be an uptickin another area.
So to mitigate risk,you needed to diversify.
Well, ESG narrowsthe range of possibilities
for diversification.
It automatically takes offthe table entire
fields,entire industries, companies
(16:24):
that are deemed unacceptableby ESG criteria.
So as you narrowthe range of investment
possibilities,you narrow the possibility
and you narrowedthe diversification options.
And that just by conventionalinvesting wisdom, just by sheer
math, means that you cannotrealize the same returns.
(16:45):
And in fact, we've seen that ESGhad a couple of popular years
during the pandemic.
2019, 2020were more popular for ESG,
but ESG has really plummeted.
ESG investments have reallytanked lately and are performing
very poorly.
I was listening
to NPR of all stations,and they had
(17:06):
someone from Mercer,not the university,
but the financial institution
on the other dayand was talking about
how ESG weighted portfolioscannot outperform the market.
They're justit's just not possible.
Investors can put money in ESGportfolios if they wish,
if they have other motivesfor investing.
But if their motiveis to generate returns,
(17:27):
that's not the best placeto put your money.
No, you use the termfiduciary duty.
So let's explain this,
because this really gets backto the people running.
Are pension fundor if they are, you know,
running a mutual fund,they they have a fiduciary duty.
Explain whatwhat that legal concept is. Yes.
(17:50):
So a fiduciary is someone whoacts on the behalf of another.
So if if you give me moneyto invest on your behalf
with clear instructionsto generate
as many returnsas possible with that money,
then my fiduciary
obligation with your moneyis to do that very thing.
There are other forms of thisjury duty.
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If you serve on the board
of directors of a company,your fiduciary duty
is to that company,not to the president,
not to any officerin the organization,
but to the entitythat is the organization itself,
which means you have to havea heightened duty
to act in the best interestsof that organization.
And anyone who's investing
someone else'smoney has a heightened duty
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to that person
to invest that money in keepingwith that person's intents.
And most people still wantto invest to maximize returns.
That's whatthe point of investment is.
If you want to put your moneytoward social causes,
well,there are charities for that.
You can donate money for thatyou can pay people.
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There are many other waysbesides investment.
Realize those goals.
But if you did want to do thatand they had the there was
an ESG theme, the sun is like,this is ESG investing.
The S&P 500.
This is not trying energystocks or are there a theme
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and people put their money
into that, then that thenin one sense that would be fine.
And also, whoever is runningthat ESG fund would have a duty
to the investors to truly investin ESG and s causes.
Well, and this isn't this raisesanother issue
of why I think ESG portfoliosare starting to tank.
And that's because the SEC
has this new name rule,which requires that it requires
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any fund that pools securities
allegedly for ESG
to, in fact, have 80% ofthose assets actually be ESG.
Because what was happening is
you've heardthe term greenwashing,
which is when ESG funds
purported to be very green, arevery environmentally friendly.
(19:56):
But in fact,they had a bunch of non-U.S.
stuff in it.
So those years, 20, 19, 2020,
when ESG securities were doingreally, really well.
Well, it turns out
one reason is becausethey weren't actually ESG.
So now the FCC, in cracking downagainst greenwashing,
is trying to to say, look,if you're going to advertise
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your fund as ESG,it better have in it
what you say is on it.
And another thing withyou'll you'll see with with
with some of these activity,in particular mutual funds
that are ESG that are veryactively managed as that,
you know, they'reprobably not the best way
to realizeyour environmental goals
because of the amount of money,the amount of money
(20:38):
you're paying in fees
for these peopleto invest your money
when you could skip all thatand just give it directly
to some activist organization
that's out theredoing something green.
And the one issue thatthat would arise with a pension
fund, particularlysince you've got
all these thousands ofof people, is a schoolteacher,
is in a statewhere are members of this thing
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Even if they all sort of wantedto invest in social causes,
they wouldn't agreeon the same social causes.
And so,
I mean, that'sone of the big issues
you see with any business,certainly a historical one
with any corporation,if they say
we want a corporationto pursue a good cause as well,
you know, amongstall the stockholders,
they're not going to agreeon the same good causes.
(21:22):
And so that's a cause ofconflict there.
Absolutely. So
but just to be clear,
with pensionsis pretty particularly clear
that even thoughsomebody is, say,
running the state pensionplan, it's not their money.
It really it really thatis money that belongs to the
beneficiaries,the members of that,
(21:44):
that is there is money that wastaken out of their paychecks
to be invested on their behalf,to make money
to pay for their retirementbenefits. That's correct.
And there's really not
a sufficient mechanism yetto determine how
to assess the wants and desiresof all those managers.
When it comes to investment,
How do you invest money if it'snot on the basis of returns?
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What is it really?
The only criterion is returns oninvestment
is maximizing returns.
And once you start getting intoanything else, social value,
there's no way you can findsomething that's representative.
Know all of those many, many,many people,
you know all the argumentsabout why companies
should be trying
to maximize their profitsbecause you maximize profit,
(22:27):
then everybody can taketheir larger profits
and contribute them to their ownfavorite causes. That's right.
So over the last couple ofyears, there is a beginning to
what's now being labeledan anti ESG movement.
So tell us a little bit amongstpeople who feel that
this is a badway for our economy to proceed.
What doeswhat were they doing in response
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and what is thisanti ESG movement?
Well, there is both a publicand a private side.
First of all, ESG is gettingcriticized by big name figures.
People like Elon Musk calling itthe devil.
And Donald Trumpcalling it something or other.
But you had an 18 governorcoalition led by Ron DeSantis
that was going to bean anti ESG coalition
(23:11):
in which
these governors of mostlyred states
were going to encouragetheir state legislatures
to oppose ESG by eitherdivesting or taking
whatever action was necessaryto combat ESG.
Every single Republicanin the United States
senator has come outagainst ESG.
Joe Manchin of West Virginiahas come out against ESG.
There's a lot of politicalpushback against ESG.
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You had 26 state Republicans,
attorneygeneral sued to try to block
a new
Department of Labor rulethat would permit
investors to consider
ESG non-financial criteriafor full on one K investments.
(23:53):
And the Republicans, in fact,
lost the attorneysgeneral lost that that lawsuit
at the trial level
and on the basisthat the Department
Labor did not act arbitrarilyor capriciously in
enacting that rule.
Now, there's a big rulethat's coming down
with the Securities and ExchangeCommission, the S.E.C..
(24:14):
I expect that to drop inNovember.
That's an unrelated issue.
That's for ESG,mandatory disclosures.
But you're seeing a lot of oflegislation at the state level
pushing back.And that takes two forms.
One is what they're callinga well, one
basically preventsthe investment of public money,
(24:34):
the public contracts, the use ofpublic money for ESG causes.
So youyou would say that if there's
if there's
any public money
being used to discriminateagainst a local industry,
whether it's agriculture,timber, tobacco, fires,
whatever, public moneycannot be used in that way.
(24:55):
The other one restricts
the investment of pension money,
in particular statepension money in nonfinancial
portfolios, non-financial fundsfor any purpose other than
financial return, so that you'renot using state pension money.
And that's that's going on.
And I think 22, 22 statesso far have adopted that.
(25:18):
So we're getting closeto about half the states
that have addressed itat at least some level.
Alabama had SB 261 that passed
last legislative sessionthat fell into the
first categoryabout the use of public money.
Okay.
They have not tackled
the pension side of things, butthose are all examples of how
sort of publiclypeople are pushing back.
(25:39):
But on the private sector,
people are divesting from ESGbecause it's underperforming.
There's a new study outby somebody named Christos
McCready's and Dr.
Marsh Margie Simon,and they're finding
is that investment portfoliosthat ignore ESG metrics
and rely
period purely on returnsin fact generate higher returns
(26:01):
that ESG portfolios are morevolatile than non ESG portfolios
and higher risk in thatthey underperform the market.
This is a studythat just came out.
According to an articlein Forbes last week,
assets under managementin ESG declined by 339 billion.
And just the secondquarter of 2023.
So investors are startingto realize, this ESG
(26:24):
is not worth it.
Like we wantreturns on investment.
We need to divest from from ESGbecause it's
not generating returns.
It was faddish in 2019, 2020,but now people have
woken up to the reality of itand they've realized that over
time,limiting the range of investment
possibility is not a long termwise strategy
(26:47):
of prudent investment. And so
ESG is dropping.
Even in the last proxy season,
we saw fewer shareholderproposals dealing with ESG,
even just on that level,even the shareholders,
those have dropped a lot.
And I think that has to dowith sort of the pushback
against Anheuser-Buschand Target for taking
(27:09):
very controversial politicalstances in their advertising
and suffering
based on consumer
demand plummeting
for their products and saying,
we're not going to shopat Target
because these productsare putting the children section
or we're not going to buyBud Light
because we don't like the wayit's being marketed
and because of the hitsthat those companies took,
(27:29):
I think we saw as shareholderssaying, well, wait a second, we
we need to take a stepa step back here.
And we can't justwe can't just sabotage
the companies that were thatwe own.
Otherwise, what arewhy are we owning these?
All right.
And just so one thing to sort oframp up here,
I think the point is like
there's somehow that thoughtthat you could either
(27:50):
pursue returns or profitsor do something
that is good for society,but profit is actually good
for society, too, isn't it?
That is such a good point.
Dan. Profits are greatfor society
because what,what what do businesses do?
They employ people.
They add value to societyby giving us goods and services
at cheaper pricesunder a state of competition.
(28:13):
And they just they add valueto our everyday lives.
And that is a wonderful thing.
Jobs, opportunities.
And they investin their communities
in many different ways as well.
What companywants to headquarter in a place
and see that place doing poorly?
Not none.
(28:34):
Then they all invest in theircommunities in different ways.
Corporations are astoundingand what they do to
improve the quality of life
and every dollar andprofit they get is is ultimately
becausesomebody purchased their profit
and then showed that they wantedto buy that good value.
Sign of valueis a sign of value.
Well, thanks so muchfor coming on and joining us.
(28:55):
And thank youall for joining us.
Join us again next timefor another E Conversations.
This has been e conversations,
a joint production of TroyChurch Vision and the Manuel H.
Johnson Center for PoliticalEconomy at Troy University.
The opinions expressedon this program represent
the viewpoints of individualauthors or contributors,
and do not necessarily reflectthose of Troy University.
This is E Conversations,
a joint production of Joy TrojanVision and the Manual. A.H.
Johnson Centerfor Political Economy.
(00:22):
Now here's your host, Dr.
Dan Sutter.
Helloand welcome to Conversations.
I'm your host, Dr.
Dan Sutter of the Johnson Centerfor Political Economy on Wall
Street has long servedas the embodiment of greed
in our economy, representedperhaps most visibly
and memorably,
by the character GordonGekko in Oliver Stone's movie.
(00:43):
Many have long calledfor investors
to consider the good for society
as opposed to their own profitsin investing their money.
The ESG movement is a modernversion of socially responsible
investing, embodying
this idea that of consideringsocietal impact.
Perhaps ironically, financeis attempts to change the world
instead of making moneyhave proven
(01:03):
even more controversialthan greed ever arise.
How is an investmentstrategy managed to become
a contentious political issue,
even being discussedby presidential candidates?
And is ESGtruly a threat to a prosperous
and thriving market economy?
Joining me in conversationstoday to discuss ESG is Dr.
Element at Hall.
He's the Grady Rogier professor
(01:24):
and executive director
of the Johnson Centerhere at Troy University.
Dr. Mendenhall has a bachelor'sdegree from Furman University,
a law degree and master'sdegrees
from West Virginia Universityand a Ph.D.
in English from Auburn.
Prior to joining Troy, Dr.
Martin Hall
worked in the AlabamaSupreme Court, and he was also
the director of the Blackstoneand Burke Center
(01:44):
at FaulknerUniversity's Law School.
Welcome back to the show, Alan.
Dan Thanks for having meas always.
I am always
very happy to be hereand very grateful to you
for having so many episodesand being a tireless
defender of market education.
Well, well, thanks.
Thanks so much.
And we'll have you on more times
(02:05):
giving your opinion of our host.
So before we get started, just
explain for our viewerswhat exactly ESG is.
I use the initials there,but they have the
they are an initials.
So explain for everybody
before we get started hereexactly what ESG is.
So ESG isthe acronym that stands
(02:26):
for environmental,Social and Governance.
And that acronym involvesthe financial non-free
natural factors and metricsthat central banks,
institutional investors,investors in general,
all sorts of financialinstitutions take into account
when they allocate capitalor assess risk.
(02:48):
So we're principally talkingabout investment criteria.
When people say we're goingto invest in ESG funds.
What they typicallyare referring to are,
more than anything else,
mutual fundsand exchange traded funds.
So a mutual fund is differentfrom an exchange traded
fund in thatthey both pool securities,
(03:09):
but a mutual fund is tradedonce a day.
The value of it is calculatedat the end of the day,
whereas an exchange traded fund
can be boughtand sold all throughout the day.
Mutual funds
are typically activelymanaged by a manager.
You pay fees,
whereas an exchange traded fund
is a passive investment vehicle,and an exchange traded fund
(03:31):
will typically track
an indexsomething like the S&P 500.
And therefore, as a passiveinvestment vehicle, it
typically outperforms the marketbecause you're not dealing
with human intelligence.
Tell it.
It's having to pick this company
or that company or this fieldor that field.
(03:51):
Mutual funds are much olderETFs are
a moreof a newer form of investment,
but they are typicallywhere we see
ESG investments occurring.
So explain a little bit like soU.S., ESG, environmental,
socialand governance components.
What would be some of the thingsthat would fit
(04:11):
under those headings? Yes.
So under the EA, for example,
you might have companiesincluded within an E
if they have committedto net zero emissions by 2050,
all sortsof environmental factors,
whether they are pertainingto biodiversity
or just in general pollutionor other initiatives
(04:33):
that those companiesmight undertake that are green.
The s would refer to socialand that can be
a wide variety of things.
I think in Europe
the social tends to involvemore workers, right?
Right.
Whereas inthe United States, the social
tends toward,
you know, diversity, equity,inclusion in the workplace
(04:56):
or commitmentsto different social causes,
whether companies are investingmoney in Black Lives Matter or
of one onesort of controversial area
in which we're seeingit is after the Dobbs
opinion is whether a companywill pay for employees
to go across the state to getan abortion in another state
where abortion is legal.
(05:18):
So these all are factorsthat fall into the. Yes,
the the G refers to governance,as you mentioned earlier.
And this is sort of boardlevel diversity
or executive compensation,those types of matters.
But I actually like to think ofthe G in the bigger picture
in terms of the shiftfrom the shareholder
to the stakeholdermodel of governments.
(05:39):
The traditional Milton Friedmanline that corporations exist
for the maximization of profitsfalls under the traditional
shareholder model,whereas the stakeholder model
is different, the stakeholdersthat are obvious would be
customers, would be employees,would be suppliers,
but stakeholders are broadlydefined these days to be society
(06:03):
writ largeor even the environment
categories that are so broadthat they're almost undefinable.
Right.
And that is the shiftthat we're principally seeing
in this ESG trend.
And then the explicit ideawould be to use your money
to advance these causesas opposed to trying to
(06:24):
make money for yourselfor make the most money you can
or make whatever return you wantwith a degree of safety.
So is really explicitlynot trying to do what
to maximize your own return,but rather to try to
advance these causesthrough your actions
or through your investments,right?
That's right.
And so there are sort oftwo sides to that.
(06:46):
The first sideis on the investor side.
So people are investingin, let's say it's an ETF
that's ESG weighted well,they put their money in an ESG
portfolio to
to to try to realizesome returns in social values.
And that is perfectly okay.
And retail investoras a household investor,
as an individual,
(07:06):
you can put your moneywherever you want to put it.
Where ESG becomesproblematic is where we have
in particular governmentmoney being invested.
So municipal bonds,pension money,
sovereign wealth funds,these are all invested
and they're invested byinstitutional investors that
(07:30):
then take their
their profits and buy sharesof publicly traded companies
and then try to pushthose publicly traded companies
into some of this ESG space
where otherwise these companieswould not a participant of ESG.
Now they've got their
shareholders telling them, hey,you need to
(07:50):
move into this space on thisparticular issue or you need to
diversify your board,or we need to get rid of your,
you know, this committee chair,because this committee chair
doesn't represent a particularethnic group or,
you know, doesn'thave you don't have enough,
you know, diversityin terms of sexuality
(08:10):
on on on the boardand all kinds of things.
But these are all pressuresthat get exerted sort of
upon companies sometimes againstthe company's best interests.
And so whether it be
through investors or pressureon like, say, the Fortune 500
(08:30):
companies to change their waysis still sort of this idea
that these businesses needto pursue these changed society.
That's right.
As opposed to eithermaximizing their own profit.
If you're talking aboutlike Ford
or Exxon or investors
going out there tryingto allocate their money to
make the best returns,the biggest returns they can.
(08:51):
Well, that's absolutely right.And it's important
to realize how powerfulthese companies are.
So the big three are BlackRock,State Street and Vanguard,
and they together have around23 to $26 trillion of assets
under management.
That's larger than the entireUnited States GDP.
Well, there are just under
$100 trillion of assetsunder management globally.
(09:14):
Well, how in the worlddo you get to those figures
when you only have
a little over 300 billionairesin the United States
excuse me, 700,
a little over 700 billionairesin United States, a little over
3000 globally.
There's just not enough
private wealth in the worldto get to those astounding
figuresin the trillions of dollars.
So where do they come from?
I already mentioned it'sgovernment money.
The sovereign wealthfunds are big ones.
(09:36):
No, explain. Explain. Yeah.
Explain what a sovereign wealthfund is, because. Sure, sure.
Everybody'sgoing to know what that is.
Yeah, well, Sovereign Wealth
Fund is basically just a stateowned investment fund.
And so Norway is very oilrich country
and it has about$1,000,000,000,000
worth of assets under management
and it's its sovereignwealth fund.
China has.
(09:56):
And so like
what Norway's done there isthey've taken some of that
royalties or some of the moneythat would have come in
from their oil,their their oil development.
And they've put itin this savings,
in fact,a savings account, right?
That's right.And they've invested that money.
And so China has overa trillion United Arab Emirates
and Kuwait have somewhere arounda trillion each.
(10:19):
Hong Kong has about 500 billion.
Qatar has about 500 billion.
So these arethese are astronomical amounts
of of of government moneythat are getting invested.
And this is notwithstandingthe pension money
that gets invested,the top 100 pension
funds in the worldamount to around $18 trillion.
So now you're starting to seewhere the money comes from.
(10:42):
This is how the big three
have that much moneyunder management,
that many assetsunder management.
That's how globally we havealmost $100 trillion of assets
under managementis through these
thesethese government investments.
And I haven't even mentionedbonds among all those.
And the other thing
that's a sort of a newertrend is
these are all institutionalinvestors.
(11:03):
So 100 years ago, you know,
most investors were justhousehold retail investors.
They were wealthy individuals.
They weren't thesebig institutional investors
In 1981, institutional investors
amounted to about 35% of ownersin the stock market.
That went to 58% in 2002.
(11:23):
And now it's over 80%.
So the stock market isis become dominated
by these institutional investorsand not by just
wealthy individuals.
And and they're the onesthat manage
all this government money. Now.
They're other formsof private money.
Their insurance moneygets invested,
(11:44):
endowments from foundations,those, you know,
university endowmentsthat are privately managed
those those thosemake it in there, too.
But these are all differentmechanisms
for how these asset managers
get so much moneyunder management.
There's this idea, though,that ESG is a privately driven
thing, and I really wouldchallenge that.
(12:07):
The interesting thing about ESGis it starts to blur
the distinctionbetween public and private.
So let'sjust take BlackRock as the big
so let's let's let's thinkabout this for a sec. Yeah.
So when you say privately
any investor today,just as any investor in the past
could, always
is free to invest their money
however they wantand if they want to,
(12:28):
you know,
for instance,
during the Vietnam War,some people wouldn't
want to invest in Dow Chemical.
They were making the napalmthat was being dropped
on villages
and people thought like, okay,even if that's profitable,
you'rethat's sort of like blood money.
You've got blood on your hands.
You're making money from makingthis product that's harmful.
And there's nothing you do.
To be clear,
(12:48):
there'snothing wrong with investors
choosing to investonly in businesses
that even if they're legal,they think like,
that's not somethingI want to be part of.
That's not somethingI approve of. Absolutely.
And that could go on the leftor go on the right
if you are an investorand you don't want your money
going toward the firearmsindustry,
then don't put it there.
If you're an investorand you don't want
(13:08):
your money going toto pornographic companies or,
you know, or whatever it is,alcohol, tobacco, you name it,
that's fine.
You can invest your moneyto maximize social value
if that's what you want to do.
You can also hire a moneymanager.
You can hire an asset management
asset manager to investyour money in those ways.
(13:29):
If you put controls on
how your investment is,and that's perfectly fine.
Where the problem is iswhen asset
managers are investinggovernment money,
you think about where all thatgovernment money comes from.
It comes from all these peoplewho really lack agency
in determining howthat money gets invested because
they're investing for
on behalf of,let's say, just as he's doing
example, let's sayit's the state of Alabama.
(13:51):
Well, the state of Alabamabecomes the client,
notwithstanding the maybe,you know, thousands
and thousands of people
whose moneyis contributing to that fund.
And so then you have a situationwhere these individuals
whose money has becomegovernment money through
pension tax, whatever it is now,they don't get to choose
(14:14):
where the money that that
that they earned in thatthey gave to their government.
Now the government's investing.
They have no agencyin determining where
wherethat money is getting invested.
So when that happens,
the investor is actingas a fiduciary.
And for for all thesepurportedly numerous
beneficiaries.
And the problem comes
(14:35):
when those investmentsare not based
on the maximizationof financial value, because now
you're investing on perceivedsocial value,
there's no wayto actually assess that.
Like what are what arethe people of Alabama want?
What does Joe want, Larry want?
And all these people,
you can't determine what theywant in terms of social value,
but it's clear that they wantreturns on financial investment.
(14:58):
That's an obvious thing, right?Yeah.
With the pension,one thing you can clearly say,
you know, obviously you don'tsimply have enough money
taken out of your payto pay the benefits.
The expected is that that moneyis going to be invested
and it's going to earn returns.
And then it's
not just what you saved,but the the primarily
(15:19):
the earnings on those returns,
especially if you start young
in your twentiestrying to save from that.
There's like 40 yearsfor that compound interest
or the compounding returns toto build up a lot of money.
So clearly people have it withthey're counting on that money.
Earning a returnis sufficient to return to
(15:40):
fund their retirement.
So that's exactly right.
And just to add to that,I mean, ESG
violates a fundamentalprinciple of investment.
I mean, the traditional wisdombehind investment was that
you were doing two things
mitigatingrisk and maximizing returns.
And that requireddiversification,
(16:01):
diversification acrossfields, across industries.
Because if there's a downturnin one area,
well, there might be an uptickin another area.
So to mitigate risk,you needed to diversify.
Well, ESG narrowsthe range of possibilities
for diversification.
It automatically takes offthe table entire
fields,entire industries, companies
(16:24):
that are deemed unacceptableby ESG criteria.
So as you narrowthe range of investment
possibilities,you narrow the possibility
and you narrowedthe diversification options.
And that just by conventionalinvesting wisdom, just by sheer
math, means that you cannotrealize the same returns.
(16:45):
And in fact, we've seen that ESGhad a couple of popular years
during the pandemic.
2019, 2020were more popular for ESG,
but ESG has really plummeted.
ESG investments have reallytanked lately and are performing
very poorly.
I was listening
to NPR of all stations,and they had
(17:06):
someone from Mercer,not the university,
but the financial institution
on the other dayand was talking about
how ESG weighted portfolioscannot outperform the market.
They're justit's just not possible.
Investors can put money in ESGportfolios if they wish,
if they have other motivesfor investing.
But if their motiveis to generate returns,
(17:27):
that's not the best placeto put your money.
No, you use the termfiduciary duty.
So let's explain this,
because this really gets backto the people running.
Are pension fundor if they are, you know,
running a mutual fund,they they have a fiduciary duty.
Explain whatwhat that legal concept is. Yes.
(17:50):
So a fiduciary is someone whoacts on the behalf of another.
So if if you give me moneyto invest on your behalf
with clear instructionsto generate
as many returnsas possible with that money,
then my fiduciary
obligation with your moneyis to do that very thing.
There are other forms of thisjury duty.
(18:11):
If you serve on the board
of directors of a company,your fiduciary duty
is to that company,not to the president,
not to any officerin the organization,
but to the entitythat is the organization itself,
which means you have to havea heightened duty
to act in the best interestsof that organization.
And anyone who's investing
someone else'smoney has a heightened duty
(18:32):
to that person
to invest that money in keepingwith that person's intents.
And most people still wantto invest to maximize returns.
That's whatthe point of investment is.
If you want to put your moneytoward social causes,
well,there are charities for that.
You can donate money for thatyou can pay people.
(18:53):
There are many other waysbesides investment.
Realize those goals.
But if you did want to do thatand they had the there was
an ESG theme, the sun is like,this is ESG investing.
The S&P 500.
This is not trying energystocks or are there a theme
(19:13):
and people put their money
into that, then that thenin one sense that would be fine.
And also, whoever is runningthat ESG fund would have a duty
to the investors to truly investin ESG and s causes.
Well, and this isn't this raisesanother issue
of why I think ESG portfoliosare starting to tank.
And that's because the SEC
has this new name rule,which requires that it requires
(19:36):
any fund that pools securities
allegedly for ESG
to, in fact, have 80% ofthose assets actually be ESG.
Because what was happening is
you've heardthe term greenwashing,
which is when ESG funds
purported to be very green, arevery environmentally friendly.
(19:56):
But in fact,they had a bunch of non-U.S.
stuff in it.
So those years, 20, 19, 2020,
when ESG securities were doingreally, really well.
Well, it turns out
one reason is becausethey weren't actually ESG.
So now the FCC, in cracking downagainst greenwashing,
is trying to to say, look,if you're going to advertise
(20:17):
your fund as ESG,it better have in it
what you say is on it.
And another thing withyou'll you'll see with with
with some of these activity,in particular mutual funds
that are ESG that are veryactively managed as that,
you know, they'reprobably not the best way
to realizeyour environmental goals
because of the amount of money,the amount of money
(20:38):
you're paying in fees
for these peopleto invest your money
when you could skip all thatand just give it directly
to some activist organization
that's out theredoing something green.
And the one issue thatthat would arise with a pension
fund, particularlysince you've got
all these thousands ofof people, is a schoolteacher,
is in a statewhere are members of this thing
(21:00):
Even if they all sort of wantedto invest in social causes,
they wouldn't agreeon the same social causes.
And so,
I mean, that'sone of the big issues
you see with any business,certainly a historical one
with any corporation,if they say
we want a corporationto pursue a good cause as well,
you know, amongstall the stockholders,
they're not going to agreeon the same good causes.
(21:22):
And so that's a cause ofconflict there.
Absolutely. So
but just to be clear,
with pensionsis pretty particularly clear
that even thoughsomebody is, say,
running the state pensionplan, it's not their money.
It really it really thatis money that belongs to the
beneficiaries,the members of that,
(21:44):
that is there is money that wastaken out of their paychecks
to be invested on their behalf,to make money
to pay for their retirementbenefits. That's correct.
And there's really not
a sufficient mechanism yetto determine how
to assess the wants and desiresof all those managers.
When it comes to investment,
How do you invest money if it'snot on the basis of returns?
(22:06):
What is it really?
The only criterion is returns oninvestment
is maximizing returns.
And once you start getting intoanything else, social value,
there's no way you can findsomething that's representative.
Know all of those many, many,many people,
you know all the argumentsabout why companies
should be trying
to maximize their profitsbecause you maximize profit,
(22:27):
then everybody can taketheir larger profits
and contribute them to their ownfavorite causes. That's right.
So over the last couple ofyears, there is a beginning to
what's now being labeledan anti ESG movement.
So tell us a little bit amongstpeople who feel that
this is a badway for our economy to proceed.
What doeswhat were they doing in response
(22:49):
and what is thisanti ESG movement?
Well, there is both a publicand a private side.
First of all, ESG is gettingcriticized by big name figures.
People like Elon Musk calling itthe devil.
And Donald Trumpcalling it something or other.
But you had an 18 governorcoalition led by Ron DeSantis
that was going to bean anti ESG coalition
(23:11):
in which
these governors of mostlyred states
were going to encouragetheir state legislatures
to oppose ESG by eitherdivesting or taking
whatever action was necessaryto combat ESG.
Every single Republicanin the United States
senator has come outagainst ESG.
Joe Manchin of West Virginiahas come out against ESG.
There's a lot of politicalpushback against ESG.
(23:32):
You had 26 state Republicans,
attorneygeneral sued to try to block
a new
Department of Labor rulethat would permit
investors to consider
ESG non-financial criteriafor full on one K investments.
(23:53):
And the Republicans, in fact,
lost the attorneysgeneral lost that that lawsuit
at the trial level
and on the basisthat the Department
Labor did not act arbitrarilyor capriciously in
enacting that rule.
Now, there's a big rulethat's coming down
with the Securities and ExchangeCommission, the S.E.C..
(24:14):
I expect that to drop inNovember.
That's an unrelated issue.
That's for ESG,mandatory disclosures.
But you're seeing a lot of oflegislation at the state level
pushing back.And that takes two forms.
One is what they're callinga well, one
basically preventsthe investment of public money,
(24:34):
the public contracts, the use ofpublic money for ESG causes.
So youyou would say that if there's
if there's
any public money
being used to discriminateagainst a local industry,
whether it's agriculture,timber, tobacco, fires,
whatever, public moneycannot be used in that way.
(24:55):
The other one restricts
the investment of pension money,
in particular statepension money in nonfinancial
portfolios, non-financial fundsfor any purpose other than
financial return, so that you'renot using state pension money.
And that's that's going on.
And I think 22, 22 statesso far have adopted that.
(25:18):
So we're getting closeto about half the states
that have addressed itat at least some level.
Alabama had SB 261 that passed
last legislative sessionthat fell into the
first categoryabout the use of public money.
Okay.
They have not tackled
the pension side of things, butthose are all examples of how
sort of publiclypeople are pushing back.
(25:39):
But on the private sector,
people are divesting from ESGbecause it's underperforming.
There's a new study outby somebody named Christos
McCready's and Dr.
Marsh Margie Simon,and they're finding
is that investment portfoliosthat ignore ESG metrics
and rely
period purely on returnsin fact generate higher returns
(26:01):
that ESG portfolios are morevolatile than non ESG portfolios
and higher risk in thatthey underperform the market.
This is a studythat just came out.
According to an articlein Forbes last week,
assets under managementin ESG declined by 339 billion.
And just the secondquarter of 2023.
So investors are startingto realize, this ESG
(26:24):
is not worth it.
Like we wantreturns on investment.
We need to divest from from ESGbecause it's
not generating returns.
It was faddish in 2019, 2020,but now people have
woken up to the reality of itand they've realized that over
time,limiting the range of investment
possibility is not a long termwise strategy
(26:47):
of prudent investment. And so
ESG is dropping.
Even in the last proxy season,
we saw fewer shareholderproposals dealing with ESG,
even just on that level,even the shareholders,
those have dropped a lot.
And I think that has to dowith sort of the pushback
against Anheuser-Buschand Target for taking
(27:09):
very controversial politicalstances in their advertising
and suffering
based on consumer
demand plummeting
for their products and saying,
we're not going to shopat Target
because these productsare putting the children section
or we're not going to buyBud Light
because we don't like the wayit's being marketed
and because of the hitsthat those companies took,
(27:29):
I think we saw as shareholderssaying, well, wait a second, we
we need to take a stepa step back here.
And we can't justwe can't just sabotage
the companies that were thatwe own.
Otherwise, what arewhy are we owning these?
All right.
And just so one thing to sort oframp up here,
I think the point is like
there's somehow that thoughtthat you could either
(27:50):
pursue returns or profitsor do something
that is good for society,but profit is actually good
for society, too, isn't it?
That is such a good point.
Dan. Profits are greatfor society
because what,what what do businesses do?
They employ people.
They add value to societyby giving us goods and services
at cheaper pricesunder a state of competition.
(28:13):
And they just they add valueto our everyday lives.
And that is a wonderful thing.
Jobs, opportunities.
And they investin their communities
in many different ways as well.
What companywants to headquarter in a place
and see that place doing poorly?
Not none.
(28:34):
Then they all invest in theircommunities in different ways.
Corporations are astoundingand what they do to
improve the quality of life
and every dollar andprofit they get is is ultimately
becausesomebody purchased their profit
and then showed that they wantedto buy that good value.
Sign of valueis a sign of value.
Well, thanks so muchfor coming on and joining us.
(28:55):
And thank youall for joining us.
Join us again next timefor another E Conversations.
This has been e conversations,
a joint production of TroyChurch Vision and the Manuel H.
Johnson Center for PoliticalEconomy at Troy University.
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