The tide of Environmental, Social, and Governance (ESG) causes has been ebbing rapidly. Many of the largest corporations in America have partially or fully reversed course, and large financial institutions have decided to pull back from their international alliances and coalitions. The Trump administration has begun an all-out war on Diversity, Equity, and Inclusion, a subset of the ‘Social’ in ESG, within the federal government.
But the most interesting contest over ESG and DEI has been at the state level. Red states have been warring over ESG policies for years. Texas and Florida led the charge in 2022 and 2023 by changing policies and passing laws curtailing ESG. Other states followed suit: Tennessee, Alabama, Indiana, Oklahoma, Montana, and many more.
These legislative advances have not always been easy. Financial companies and their lobbyists, as well as complacent pension managers and state treasury officials, have threatened financial Armageddon should some of these “anti-ESG” bills be implemented. While some caution should be taken when passing legislation affecting billions of pension dollars and state funds, most of the “costs” projected by pension officials and lobbyists are blatant scare tactics with limited connection to reality. Price tags in the billions of dollars have been used to scare legislators and to provide ammunition for lawsuits to block state reforms on finance and ESG.
One such claim comes from opponents of Wyoming’s latest “anti-ESG” bill. The state Treasurer, Curt Meier, argued that stringent requirements and penalties for asset managers who pursue ESG objectives over financial returns will drive away half of his staff and make Wyoming’s public funds unattractive to top asset managers: “we’re going to be left with nobody to invest, no markets to invest in.”
But when’s the last time you heard a major institutional asset manager turn down $30 billion because it was too difficult to manage? It beggars belief that Wyoming would somehow struggle to find competent managers for its assets. Any financial adviser who objects to investing money for returns rather than for ESG goals ought to be avoided anyway!
State legislators increasingly recognize that they wield significant financial influence when deciding who will manage their financial assets. Texas does not “need” Blackrock or any of the large banks to manage its finances or to buy its bonds. Even if every major bank would refuse to work with Texas, new firms would emerge to profit at their expense. The claim that states won’t have competent managers and firms to work with if they restrict the use of their funds from DEI and ESG priorities is ludicrous.
Promoters of the status quo also argue that the three major institutional investors — Blackrock, State Street, and Vanguard — offer the lowest management fees. While that is true, at least for now, it should not matter much to policymakers. The difference between management fees from the big three and other competitors, like Strive, are negligible — usually less than two tenths of a percent, or $2,000 per million dollars. This is a rounding error compared to the potential for lower returns of multiple percentage points with funds that prioritize ESG rather than pursuing the best financial outcome.
More importantly, the big three asset managers may have broken multiple state laws and violated their fiduciary duties. It doesn’t matter if an embezzler, fraudster, or ponzi scheme artist offers you a lower management fee — state officials have an obligation to their pensioners and their citizens to avoid working with such people. As demonstrated by the American Airlines ruling, a notice letter to the largest banks, and the recent lawsuit against Blackrock, State Street, and Vanguard, investing with large firms who prioritize ESG considerations is fraught with legal risk.
The debate raging in Wyoming is the latest example of the dynamics and arguments laid out here. The state treasurer and other public officials have claimed the new bill will cost up to $5 billion, with a “B”, over the next three years if passed. Such claims don’t pass the smell test — for these estimates to be true, the state fund of $30 billion dollars would have to run five to ten percentage points lower than the status quo for several years in a row — a truly staggering loss of return.
How could losses that large emerge when the difference in management fees is a few tenths of one percent? And the funds will be invested for maximum financial returns rather than non-pecuniary ESG goals. If ESG investing somehow offered a five to ten percentage point higher return than non-ESG investing, the wealth-maximizing strategy would have no conflict with ESG. We know the opposite is the case. If anything, ESG funds have had weaker performance than non-ESG funds and the general market over the past three years.
Of course, states should also avoid playing favorites or putting their thumbs on the scale when it comes to how public money is managed. Pursuing the best financial returns, and keeping non-pecuniary considerations out of the picture, is one thing. Requiring pension money to be invested in fossil fuels or any other industry for political or local economic reasons is another.
Republican legislators have been accused of using state funds as a political football, but the laws on the books champion financial returns and fiduciary responsibility, not favoring pet industries or punishing less-favored ones.
Ultimately, seeking the best financial returns should be the only guiding light for how state funds are managed. Normally such a declaration would be sufficient. But the bait and switch game played by ESG advocates over the past decade, and the clear history of misleading investors about the financial returns of ESG-investing, have pushed state legislators deeper into the weeds of how their assets are managed.
Many legislators believe they must explicitly exclude ESG prioritization to make sure their assets are properly managed. If Blackrock, large banks, and other asset managers don’t like the extra scrutiny and sometimes ambiguous strings attached to managing public money, they have no one to blame but themselves.
