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U.S. Sen. John Barrasso is among those criticizing the Biden Administration over a new rule allowing retirement funds to take into account environmental, social and governance (ESG) investing.Chip Somodevilla/Getty Images

Gus Carlson is a U.S.-based columnist for The Globe and Mail.

Some call it woke capitalism, others call it ethical investing. Whatever your preferred term, the collision of ideologies around environmental, social and governance funds – ESGs – is getting messier.

Anti-ESG political rhetoric is rising, while inflows of capital into funds – and the number of new funds – fall. Staggering fees and questions about the integrity of companies’ ethical claims dog the sector. The backlash is so strong, several big firms with ESG funds say the risks are now material.

And as often happens when politics and finance bump, it is average investors seeking safe havens for things like retirement savings who get whipsawed, confused and often hurt by the fallout.

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For some proponents of ESG, the idea is not so much investing but a high-profile virtue signal tied to the progressive political agenda driving causes such as social justice and climate change. The pitch often sounds convincing: If you invest in these funds, made up of companies that claim to be ethically exceptional, you will do well and do good at the same time.

But ESG has become increasingly troubled, with political backlash posing significant risk. In announcing the move to pull state money from ESG funds, Florida Governor Ron DeSantis, a likely Republican presidential candidate for 2024, suggested the goal of ESG was to bypass democracy and ruin capitalism.

At its heart, as critics suggest, ESG is at times a woke Trojan horse. Many see the feel-good gift of social conscience on the outside, but inside are all sorts of enemies that can get past an investor’s ramparts and wreak havoc.

Among them, the falsifying of credentials, called greenwashing. Many component companies in ESG funds have been exposed for lying about the ethical accomplishments that earned them their places. A year ago, Morningstar stripped 1,200 companies worth US$1-trillion of their sustainable status for misrepresenting their ethical hygiene and revealing that they were, in fact, less clean than many companies not considered worthy of ESG status. Experts suspect greenwashing goes even deeper than this.

ESG fees are often much higher than other funds – with premiums of up to 40 per cent higher – hence the nickname “greeniums.”

Most important, if you believe these funds are on the side of the angels, you might expect more heavenly performance. But returns of ESGs have been inconsistent – sometimes higher, sometimes lower than the S&P 500 – considering the high fees and supposed ethical exceptionalism of many companies that are lauded as the moral foundation of the funds.

The backlash against ESGs in the U.S. has been swift and sharp. More than a dozen U.S. states have pulled funding, including pension and retirement money, from ESG funds and launched investigations into the practice. BlackRock, the world’s largest money manager, said Republican-led legislatures pulled more than US$4-billion from ESG-related asset management accounts last year.

The U.S. Congress recently voted to bar pension funds from considering ESG factors, with House Speaker Kevin McCarthy saying that to do otherwise would let “Wall Street use your retirement to fund left-wing political causes.”

While the battle lines in this conflict are largely partisan, the resulting impact is not simply ideological – it is tangible. The cuts to the firms that run ESG funds have not been flesh wounds. Several big U.S. financial companies offering ESGs, including BlackRock, Blackstone, KKR and T. Rowe Price consider the backlash a material risk.

That risk is reflected in a sharp decline in inflows, which in 2022 dropped 70 per cent over the previous year, and there was a 60 per cent drop in the number of new funds, according to Morningstar

To be sure, the reality has not yet fully dawned. Many investors have become immune to partisan posturing on both sides, but they might be confused by mixed signals from high-profile influencers in the financial services world.

Jamie Dimon, JP Morgan’s CEO, is one of them. In media coverage last fall, Mr. Dimon was quoted saying some investors don’t care about ESG, and scolded companies for “ceding governance to do-gooder kids on a committee” whose members are selected for their apparent chops in ESG. Ironically, JP Morgan bills itself as an ESG-conscious organization.

They say the rich are different than you and me, which may be true in many respects. But whether you have one dollar or a billion of them, when you invest money you expect a return, and you measure the risk versus the reward of any investment strategy.

As the noise around ESG funds gets louder and their flaws are exposed, investors must decide whether it’s realistic to expect they can achieve both their financial and social goals using the same instruments. Ideology is fine until it hurts the bottom line.

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