Senate Republicans are introducing legislation directing retirement plan sponsors to select investments solely based on monetary factors, an extension of the position adopted by the Trump Administration Department of Labor. The sponsors to the legislation defend it by arguing that retirement accounts should be off limits to politics. The debate stems from the increasing criticism of pension and mutual funds that incorporate environmental, social, and governance (ESG) factors into their investment policies.
In challenging investment managers’ focus on ESG data, however, critics conflate two distinct issues. A body of empirical literature makes the claim that ESG data is relevant to evaluating a company from an economic perspective. We term this a “value-based ESG strategy.” For example, portfolio managers may invest in companies that they believe face strong growth prospects because they have products to help in the mitigation and adaption of climate change, or in companies that have strategies which will enable them to transform their business models in the fact of climate change. This is a value-based strategy. Of course, this assumes a particular perspective on the risks associated with climate change—one can argue that climate change is not real or that, even if it is, regulators will not impose costly changes on companies. The point, however, for such portfolio managers climate change is an economic risk, and their incorporation of climate-related data is a value-based investment strategy.
Investors who believe you can make money by investing in companies that are addressing this problem can invest in the BlackRock Future Climate and Sustainable Economy ETF (BECO). Notably, BECO purports to be investing for value, not values, stating that it “seeks to maximize total return by investing in companies that BlackRock Fund Advisors (“BFA”) believes are furthering the transition to a lower carbon economy.” Similarly Morgan Stanley touts its sustainable equity funds as outperforming their traditional peer funds.
In contrast, Senate Republicans’ real concern appears to be investments that employ values-based strategies—that is, investing according to a set of principles irrespective of any link between those principles and economic value. An example of a values-based fund is the S&P 500 Catholic Values ETF (CATH). As the fund’s prospectus explains, “The S&P 500 Catholic Values Index applies exclusion criteria to the constituents of the S&P 500 in order to create a benchmark aligned with Catholic values. These values are consistent with the Socially Responsible Investment Guidelines outlined by the United States Conference of Catholic Bishops (USCCB). The index is designed for investors who wish to track a benchmark that is consistent with USCCB guidelines.” Notably, the fund’s website contains an explicit disclaimer about the risks of a values-based strategy: “CATH’s consideration of the Guidelines in its investment process may result in choices not to purchase, or sell, otherwise profitable investments in companies that have been identified as being in conflict with the Guidelines. This means that the Fund may underperform other similar funds that do not consider the Guidelines when making investment decisions.”
Concededly, the line between values-based investing and value-based investing is unclear, and few funds are as explicit in disclaiming the link as CATH. At the same time, many such funds are explicitly marketed as tools by which investors can invest according to their values. As a result, it may be difficult for investors to determine whether they are foregoing economic value when they invest in an ESG fund.
For example, on September 6, 2017, Point Bridge Capital, LLC launched the “Point Bridge GOP Stock Tracker ETF,” now called the “Point Bridge America First ETF,” with the ticker symbol of MAGA. In large and bold letters the homepage of the website for the fund states: “Bring Republican Investment Values to Life by Investing in the MAGA ETF.” The website explains Politically Responsible Investing® as “allow[ing] people to invest in companies that align with their Republican political beliefs.” The MAGA Index is made up of “the top 150 companies from the S&P 500 Index whose employees and political action committees (PACs) are highly supportive of Republican candidates.” MAGA is thus a good example of values-based investing.
Notably, nothing in MAGA’s fund materials purports to tie its investment strategy to economic value. Rather, the underlying rationale for the fund is that:
Money matters in politics, affecting elections and the creation of policy in Washington. Corporations continue to take political stances and actions that ignore the political beliefs and shared values of millions of Americans. The left is using corporate America to silence conservatives and promote their agenda. While some people have boycotted companies with whom they disagree, they remain invested in these companies in their mutual funds and stock portfolios. We have created the MAGA ETF as a solution to these issues.
CATH and MAGA illustrate that responsible investing is not limited to left-leaning funds. In essence, each is a form of “Socially Responsible Investing (SRI),” just based on a different set of values for the screening process. The current rabid debate about ESG investing has its origins in SRI. While SRI can be traced back some 200 years to the Quakers, it can be said to have formally begun with the launch of the Pax World Fund (which still exists) in 1971 that by two “United Methodist ministers—Luther Tyson and Jack Corbett—looking to avoid investing church dollars in companies contributing to the Vietnam War, founded the ground breaking Pax World fund.” The original SRI funds, created for religious groups, screened out “sin stocks” like alcohol, firearms, gaming, and tobacco. Thermal coal, especially, and oil and gas are increasingly on the list for exclusion. Proponents of negative screening also often make the argument that this will put pressure on these companies to change, or even go out of business, by raising their cost of capital. This is a highly researched topic but a recent working paper with one of us as a co-author suggests that negative screening has no effect on the returns of sin stocks.
Although SRI started out on the left, it is now, somewhat ironically, being incorporated by the right. A March 26, 2021 Wall Street Journal article starts by saying “Values-based investing options for conservatives have lagged behind those available to investors concerned about climate change, diversity and animal rights.” It notes with satisfaction that “conservatives are taking a page from liberal investors.” Perhaps unwittingly, the WSJ is bestowing legitimacy on the use of SRI to influence company behavior, particularly when it is combined with strong shareholder engagement with the company’s board of directors and senior management. It’s just that what is “socially responsible” is a function of one’s political views.
The appeal of values-based funds—on either side of the political spectrum—is that people can invest their money in companies they think are living values they care about. For example, the SPDR® SSGA Gender Diversity Index ETF “seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector.” State Street does not claim to be seeking “outperformance,” and there is a body of empirical research showing shows that more diverse groups make better decisions. But it is unclear whether State Street is seeking to market its fund in terms of economics or to those who are seeking a values-based strategy incorporating diversity.
Animal rights is perhaps more obviously a values-based approach. Those with this investment conviction can invest in the US Vegan Climate ETF (VEGN). “Through its passive rules-based approach VEGN seeks to avoid investments in companies whose activities directly contribute to animal suffering, destruction of the natural environment and climate change.” VEGN makes no performance claims, but it is conceivable that those companies for which this is an issue will attract better people and more customers.
A separate question is the extent to which values-based funds behave in a way that is consistent with their marketing. Recent articles, for example, have challenged so-called green funds for not living up to their claims because they hold investments in energy companies. The analysis is difficult, however, in part because there is no universal definition of ESG. Similarly, reasonable people can disagree on what investments are consistent with any values-based investment strategy. Again, consider the MAGA fund. MAGA is based on an index which “uses an objective, rules-based methodology” to identify Republican-friendly companies in the S&P 500® Index, defined in terms of campaign contributions and having at least 50% of their assets in the U.S.
Whether MAGA’s holdings can fairly be characterized as “companies that align with your Republican political beliefs” is less clear. At present, MAGA’s largest holding is Constellation Energy which proudly says on the homepage of its website: “Constellation is now America’s LEADING CLEAN ENERGY COMPANY! We’re the nation’s leading provider of carbon-free energy and are committed to being 100% carbon-free by 2040.” Another company in its top 10 holdings is NextEra Energy which states that, “A REAL PLAN FOR REAL ZERO. NextEra Energy has a plan to lead the decarbonization of America.” The homepage of its website also features its “2022 Environmental, Social, and Governance Report.” There is not a single major oil & gas company in MAGA’s top 10 holdings. This suggests that Republican values aren’t necessarily inimical to…
Read More: The Politics of Values-Based Investing