As States Escalate Resistance, ESG Backlash Could Come At A Cost To Investors

State and local governments in red states across the country are putting up increasingly stiff resistance to the idea of ESG-based investing, and although the movement known as anti-ESG is often dismissed as political theater, investors could lose out.

By cutting out funds that have implemented strategies based on ESG investing — in which environmental, social, and governance policies and practices are considered when making investment decisions — sources say these states reduce options and opportunities that the financial system sees as the wave of the future.

Depending on how much political traction anti-ESG gets as a wedge issue, it might grow enough to take on a blue-state/red-state divide, with the former encouraging ESG and the latter discouraging it as a matter of policy.

"I hope not, but I am concerned about that," Hodes Weill & Associates partner Susan Swanezy said. "That would be hard because a lot of these managers have national footprint, and the vast majority of investors really do believe, long term, that ESG is the direction we need to go."

Texas in 2021 led the charge into anti-ESG with a law forbidding its six public pension funds from investing in financial products that “boycott energy companies.” This year, Florida went further, banning its public funds from considering ESG at all when making investments.

An official statement in August from Gov. Ron DeSantis said that the Florida State Board of Administration directed state fund managers to invest "without considering the ideological agenda of the environmental, social, and corporate governance (ESG) movement." 

The resolution directing the change in ESG policy by Florida asserts that ESG constitutes "an ideology" that is an expression of "corporate power" and has been foisted on the American people, particularly the people of Florida. 

The governor's office didn't reply to a request from Bisnow for further comment.

Also in August, attorneys general of 19 states signed a forceful open letter to investment giant BlackRock, asserting that through ESG, the investor is pursuing a "quixotic climate agenda" to "circumvent the best possible return on investment."

"Attacks on ESG and sustainable investment are largely political attacks," said Bryan McGannon, policy director for US SIF, a foundation that encourages sustainably minded investment.

McGannon added that so far, the impact of these attacks has been minimal.

Firms are still offering, if not growing, their sustainable investment offerings, and companies are taking up sustainability measures because their employees and customers are demanding it, McGannon said.

As in any market, removing options has repercussions for the customer.

"Plan beneficiaries will possibly lose out," McGannon said. "They will have fewer options. If the pension board isn't allowed to consider the ESG factors, that might expose them to additional risk over time, and they may not have as much growth within their fund."

Since the anti-ESG movement is so new, however, it is too soon to quantify how much it might cost investors, though a study published in 2022 argues that firms' sustainability performance, measured by their ESG scores, has a direct bearing on their cost of capital. 

Investors achieving strong ESG performance typically have access to cheaper debt and equity financing since financial institutions consider them lower risk than weaker performers, according to the report, which was published as a paper in the International Journal of Applied Economics, Finance and Accounting.

University of Pennsylvania professor of management Witold Henisz, director of The ESG Initiative at the Wharton School, said the anti-ESG movement is more ideological than it is economic, but it probably is having a short-term cost for some investors.

"It's imposing a cost on companies like BlackRock," Henisz said. "They're losing some business from Texas, but there's no way they're going to abandon modeling climate change. The consequences of that would be orders of magnitude more."

On the whole, anti-ESG has some of the hallmarks of a wedge issue that divides urban populations from rural voters, Henisz said.

"BlackRock is still doing what they've done before, but could they slow down? Could they be less forceful? Could they be less of a strong voice? I think so," Henisz said. "And that could be amplified in the media and make other investors even more hesitant about ESG. All that's a real possibility." 

The anti-ESG movement could receive more oxygen for a number of reasons, one of which is perceived missteps that are part of any relatively new movement, said Mike Stopka, a Buro Happold principal who leads ESG and sustainability consulting.

"[ESG is] trying to separate the wheat from the chaff right now," Stopka said. "Some bad actors do greenwash, and then provide plenty of ammunition for anyone who's detractors to say, ‘Look at what this movement is.’" 

The best version of ESG is really nothing more than a company or an organization setting goals to improve its environmental performance, Stopka said, including energy use, wastewater, air quality and other sustainability metrics.

Confusing matters more, there is still disagreement about how to define ESG, Stopka said: Who oversees it? What standards are applied to reach ESG goals?

"Good actors are really doing everything they should, following science-based targets," Stopka said. "We're seeing more of that, but we still see the bad actors as well."

Even so, whatever places like Texas or Florida do, they are up against an ESG movement that is worldwide, Swanezy said, with governments that represent about 90% of global GDP committing to some form of net zero.

“Perhaps this is new and politically charged in the U.S., but it’s not in any other country," PwC Advisory Real Estate partner Katherine Huh told Bisnow earlier this year.

"Long term, we're going to be headed in the right direction, but that doesn't mean that progress is always linear," Swanezy said. "We're going to have these situations where political points are being scored."

The momentum will probably remain with ESG, however, she said.

"I think we can prove over time that, especially with effective sustainability initiatives, ESG isn't hurting returns, and in fact is enhancing returns," Swanezy said.

Investors are actively seeking out companies and investments with strong ESG commitments because they believe it the responsible thing to do, and they know these assets are better-positioned to weather future hardships, Lendlease Americas Head of Sustainability Sara Neff told Bisnow by email. 

"There is a deep business case for ESG, and that sentiment is shared by our investors and other industry partners," Neff wrote. "The best defense against anti-ESG sentiment in real estate is to develop high-quality, sustainable properties. Ones that outperform traditionally built structures and that appeal to a wide range of stakeholders."