Sustainable investing US anti-ESG discourse implications

The flow of state-level initiatives is likely to continue into next year as failed or pending bills are likely to be introduced again in the next legislative session across the country.

To understand the implications for investors, we looked at a sample of 96 ESG-related bills and regulations introduced or approved until the end of April 2023. We categorized two-thirds as “anti-ESG” and one-third as “pro-ESG.” Broadly, they were divided across states in predictable partisan lines, and thematically can be categorized into two types:

Public-procurement requirements: Some of these laws or regulations extend outside of the investment domain, prohibiting state entities from considering ESG factors when contracting with service providers (as Idaho House Bill 191 exemplifies). Others in this category prohibit the state treasury or local government from contracting banks that “boycott” specific industries (such as firearms or fossil fuels) for their investment banking or cash management needs. Tennessee House Bill 2672 and Texas State Bill 13 illustrate this type of legislation.

Investment-strategy requirements for public pension funds: These are legislation restricting the ability of public pension funds to use ESG information in investment decisions. While these bills make up a majority of the group, they tend to vary in the language used. Idaho Senate Bill 1405, for example, prohibits fiduciaries from considering ESG criteria if they go against the investment objectives of a prudent investor, but allows for ESG alternatives to be offered as part of a menu; others do not provide explicit exemptions.

Note that in this category we have seen bills explicitly favoring sustainability or ESG investments for public pension plans as well. For example, California, Colorado, New York, Maine, Maryland, and Minnesota either explicitly permit or require state pension boards to consider ESG and climate risks and invest or divest based on that information.

What about federal laws? While state- and local-level pension funds are the domain of state legislatures, private sector volunteer contribution retirement plans (ERISA plans) are governed by federal bodies. Currently, the Department of Labor explicitly permits ERISA fiduciaries to consider ESG factors while also maintaining their investment requirements. The House of Representatives passed a bill that prohibits ESG-focused strategies from being the default investment option in ERISA plans, but allows ESG options to be offered assuming that fiduciaries inform plan participants of any additional costs from considering sustainability options (e.g., additional fees, etc.). A similar bill passed the Senate earlier this year and was vetoed by President Joe Biden.

What does this all mean for investors? We look at implications on the assets invested in explicitly tagged sustainable investing strategies, and on investment opportunities.

SI assets under management (AUM): Explicit bans on ESG strategies may seem like a dampener on the industry, but context matters. According to the National Association of State Retirement Administrators, as of 4Q22, the combined value of all public pension plan assets across all US states was USD 5.27tr. Nearly half of this, or USD 2.2tr, is from California, New York, and Texas. By contrast, private sector retirement plans (covered by federal rules) had more than double the assets, at USD 13.1tr, at the end of 2021, according to the latest available data from the Congressional Budget Office (CBO). While these public and private retirement account investments are significant, they do not make up even half of the total AUM in the United
States, which is estimated at USD 59–66tr, based on data from McKinsey and the US Sustainable Investment Forum.

As of 1Q23, Morningstar estimated that USD 233bn—a small chunk of the total AUM—were invested in US-domiciled strategies that included sustainability explicitly in their prospectus. Putting it all together, in our view, the added hurdle for retirement plans to invest in SI strategies could be a barrier down the line if asset managers are concerned about headlines; yet, in practical terms, there continues to be significant room for SI strategies to grow given the low penetration of sustainability-focused strategies in the US market.

Investment opportunities: We do not expect anti-ESG headlines to meaningfully impact opportunities for investors, for two reasons. First, fundamental drivers supporting the SI thesis remain in place; consumer focus remains steadfast (between 2017 and 2022, products with ESG claims grew 1.7 percentage points faster than peers, according to McKinsey), while the cost of inaction can compound (for example through increasing insurance costs due to climate-related events, as we discuss in the next section in this report). Furthermore, US federal- and state-level funding such as those included in the Inflation Reduction Act (IRA) and the CHIPS Act support companies tied to sustainability strategies, as we discuss in our Made in America report, published 27 June 2023.

Finally, a question sparked by the headlines is whether ESG is “dead.” In our view, as public attention focuses on the three-letter acronym, it is likely that investment managers will move away from marketing ESG as a benefit, except for strategies that are explicitly sustainability-focused. Sustainability considerations continue to present compelling investment opportunities, in our view, and we expect this to continue to be reflected in investor interest, longer-term performance, and product availability moving forward.

Read the full report Perspectives: US anti-ESG backlash implications, Swiss emissions vote, wildfire season impact 5 July 2023.

Main contributor: Amantia Muhedini