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Daniel S. Kern

Portfolio > Portfolio Construction > ESG

The Backlash Against ESG Investing Is Here

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What You Need to Know

  • Advisors that exaggerate or mislead clients and shareholders about the use of ESG face significant potential penalties.
  • They should understand the trade-offs implicit in exclusionary approaches for clients who prioritize values alignment for their investments.
  • ESG factors are an important, but not the only, investment consideration for many of the largest and most influential asset managers.

Environmental, social and governance, or ESG, investing grew rapidly in recent years, with vigorous promotion from many large asset managers and generally positive media attention. 

The honeymoon for ESG has ended this year, with high-profile intervention by regulators, lagging performance, and negative commentary from Tesla founder Elon Musk (“ESG is a scam”), Florida Gov. Ron DeSantis (“We are protecting Floridians from woke capital”) and The Economist (“Three letters that won’t save the planet”). Given the heated rhetoric surrounding ESG today, advisors should be a source of impartial guidance on this increasingly divisive topic.

Regulatory Scrutiny Is Growing

The Securities and Exchange Commission is focused on claims made by investment advisors and investment companies about ESG, with Goldman Sachs, Deutsche Bank and BNY Mellon among the companies either fined or under investigation. The overarching message from the SEC is that “advisors should say what they do and do what they say.” Advisors that exaggerate or mislead clients and shareholders about the use of ESG face significant potential penalties. 

The SEC has also scrutinized asset manager use of ESG ratings from ratings firms such as MSCI, Morningstar and S&P. Differences between credit ratings and ESG ratings appear to be an area of regulatory concern, particularly when ESG ratings are the primary determinant of inclusion or exclusion in a portfolio. 

Credit ratings for a single company tend to be highly correlated, providing an assessment of a bond issuer’s ability and willingness to pay. In contrast, multiple academic studies have shown that there is a low correlation of ESG ratings from major rating firms. 

A closer look at the ESG ratings process provides a defensible explanation for ratings differences. A company that earns high marks from one ratings firm may earn dramatically lower ratings from another for legitimate reasons, as ESG ratings may use different criteria, weighting methodology or measurement approach,

Musk’s critique of ESG as a “scam” is an illustration of the ambiguity that can arise when trying to define whether a company is good or bad from an ESG perspective. Tesla is a favorite of environmentally focused investors for its leadership in the climate transition. Social- and governance-focused investors, however, may be less enthusiastic about Tesla given shortcomings in the firm’s board structure, Musk’s battles with regulators, and labor relations that have arguably shortchanged worker safety. 

ESG Performance Has Lagged Broad Benchmarks This Year

Some enthusiastic promoters of ESG investing assert that ESG-focused funds will provide superior performance to that of non-ESG funds, a claim seemingly validated by performance of ESG-focused funds from 2016 through 2020. Sentiment toward ESG has turned more skeptical this year. Underperformance of many ESG-based funds has contributed to rising anti-ESG sentiment and launches of anti-ESG or “anti-woke” investment offerings. 

The assertions of the most vocal proponents and detractors may neglect relevant factors that advisors should consider. ESG-focused funds frequently hold a higher proportion of technology stocks and a lower proportion of energy stocks relative to broad-based indexes, contributing meaningfully to outperformance when technology stocks were market leaders and energy stocks market laggards from 2016 through 2020. 

The surge in energy stocks and reversal of fortune for technology stocks has been an important factor in ESG-focused fund struggles this year. It may be fair to argue that ESG investing was neither inherently great in 2020 nor inherently bad in 2022.

‘Values’ and ‘Value’ May Not Have the Same Meaning

Explaining the distinctions between terms is an important aspect of the advisor-client dialogue. Many clients seek alignment between their investments and personal values. Exclusionary approaches eliminate individual holdings or market sectors that investors wish to avoid. For example, many climate-focused investors embrace strategies that exclude traditional energy and utility stocks. 

Exclusionary approaches are commonly selected for clients who prioritize “values” alignment for their investments. Advisors should understand the trade-offs implicit in exclusionary approaches. For example, tobacco stocks represent a very small part of the S&P 500 index, mitigating the potential opportunity cost of avoidance. In contrast, more than 20% of companies in the S&P 500 have some involvement in animal testing, so a blanket avoidance of animal testing would significantly reduce the investment opportunity set.

Many asset managers incorporate ESG factors into the assessment of the appropriate intrinsic “value” of an investment. ESG factors are an important, but not the only, investment consideration for many of the world’s largest and most influential asset managers. 

Asset managers such as Pimco, GMO, T. Rowe Price, TIAA, Calvert and Parnassus incorporate ESG factors believed most likely to positively influence financial performance into traditional financial analysis. According to Parnassus CEO Ben Allen, “ESG done right can have a positive long-term impact on performance.” 

Asset managers that incorporate ESG factors cite Wells Fargo, PG&E and Experian as companies in which ESG shortcomings created a material decline in the intrinsic value of the stock. According to EY Global Deputy Vice Chair Katie Kummer, “ESG information can serve two purposes: to assess financial risk and to assess social impact. These uses are not mutually exclusive but are easily confused.”


Advisors play a vital role in providing education, helping clients decide what approach or combination of approaches best aligns with the client’s preferences. Some clients may prefer the values alignment provided by an exclusionary approach; ESG-focused “value” strategies may resonate more with other clients.

Another key role for the advisor is to look beyond hype and sound bites to assess the authenticity of different investment offerings and merits of arguments about ESG investing. Ultimately, a well-informed client is more likely to remain a satisfied client.

Daniel S. Kern is chief investment officer of TFC Financial Management, an independent, fee-only financial advisory firm based in Boston. Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds.

Daniel is a graduate of Brandeis University and earned his MBA in finance from the University of California, Berkeley. He is a CFA charterholder and a former president of the CFA Society of San Francisco. He also sits on the board of trustees for the Green Century Funds


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