On Wall St., ‘Socially Responsible’ Is Common Sense. In Congress, It’s Political.

A deeply rooted approach to investing and social action is taking its lumps.

Often known as E.S.G. investing, this approach takes its name from the environmental, social and governance factors that are used by millions of people in countless investment, business, lifestyle and government policy decisions every day.

In the financial world, trillions of dollars have been placed in investments that take E.S.G. issues into account. “E.S.G. investing is now totally mainstream,” Jon Hale, head of sustainable investing research for Morningstar. “It’s part of the thinking of every major investment company because, at its core, it’s just common sense.”

Yet as this approach has grown in popularity, it has set off a powerful political backlash. That was evident in Congress this past week, when the House and Senate approved bills aimed at restricting E.S.G. investing in workplace retirement accounts in the United States.

The White House has said President Biden will veto the legislation, so what happened in Congress won’t have immediate effects.

A Protracted War

But this is just one skirmish in a partisan war. As my colleague, David Gelles, has written, Republican attorneys general from 25 states have filed suit to block the Labor Department rules. Republican state treasurers have pulled hundreds of millions in investments from firms like BlackRock, whose chief executive, Larry Fink, has been at the forefront of E.S.G. investing.

The stakes are enormous: The Labor Department rules don’t merely permit the use of environmental, social and governance factors in choosing investments. They also have the potential to advance shareholder democracy in publicly traded corporations. In a little noticed but profoundly important provision, the rules make it easier for U.S. workplace retirement plans to use E.S.G. principles in casting crucial votes in pivotal corporate contests.

Worried about climate change? It’s not far-fetched to believe that under the Labor Department rules, and a few further changes, consistently applied, it may be possible one day for you to use your hard-earned retirement money to influence big companies to curb their carbon emissions.

Our Coverage of the Investment World

The decline of the stock and bond markets this year has been painful, and it remains difficult to predict what is in store for the future.

Central Values

I first knew E.S.G. investing by another name in the 1970s: socially responsible investing, when it largely applied to divesting assets from the apartheid regime in South Africa. These days, it is often called sustainable investing because of the rising urgency among many investors to find sustainable alternatives to fossil fuels.

Whatever you call it, E.S.G. investing relies on a simple notion — that a thinking and aware person, who understands that public companies affect and are affected by the world, must take into account factors beyond the earnings numbers that these companies spew out each quarter.

The idea is that you can’t make intelligent and informed investment choices without understanding how companies deal with issues like equity, diversity and inclusion in the workplace, women’s access to reproductive health care and, of course, climate change. That is especially true for “fiduciaries” — those charged with making prudent decisions for others.

Fossil fuel companies like Exxon and Chevron, for example, have been enriched as global energy supplies were disrupted in response to Russia’s invasion of Ukraine. While the S&P 500 dropped more than 18 percent in 2022, energy was the only sector to rise, with a total return of almost 67 percent, with dividends.

For investors who held these companies in their portfolios, energy was a bright spot. I invest with broad low-cost index funds that hold the entire market. I therefore owned fractional shares of these companies. That was great for my returns.

But does that mean that fossil fuel companies are a good long-term bet in a time of global warming, or that people with a conscience should be heedless of the damage caused by burning oil, goal and gas?

Somehow, what economists call “externalities” — in this case, the environmental cost of burning carbon — need to be part of a fair analysis of these companies’ value. Market pricing isn’t doing the job.

The Role of E.S.G.

That’s where E.S.G. comes in. “There are many approaches within E.S.G. investing,” said Tim Smith, a senior policy adviser and founding staff member at the Interfaith Center for Corporate Responsibility, who was present at the creation of the socially responsible investing movement. “It’s now a very big tent."

But what exactly constitutes a modern E.S.G. fund is open to dispute.

A year ago, early in the war in Ukraine, I pointed out that some stock analysts were arguing that to combat Russian aggression, the height of social responsibility required putting investment money into the stocks of companies that make weapons. That seemed absurd to the managers of many E.S.G. funds, which have, classically, eschewed weapons, above all else.

Then there are indexes that try to filter out stocks that don’t meet E.S.G. criteria, but occasionally produce unexpected results. Last year, for example, Tesla, the electric carmaker, was excluded from the S&P 500 ESG index because of “claims of racial discrimination and poor working conditions,” S&P Dow Jones Indices said. But Exxon was included because it was deemed better than peer energy companies.

The Securities and Exchange Commission has proposed rules that would provide more clarity, requiring a fund that labels itself E.S.G. to meet basic thresholds. If a fund says it invests in certain kinds of assets, it must actually do so for at least 80 percent of its holdings.

“Greenwashing,” or the misleading labeling of investments as good for the environment, has become so widespread that a major E.S.G. trade group has trimmed its estimates of the size of E.S.G. investing. After years of reports of exponential growth, the group, US SIF: The Forum for Sustainable and Responsible Investment, found in December that E.S.G. investments in 2022 amounted to $8.4 trillion.

That’s a staggering total, but it is less than half the $17.1 trillion found in a 2020 survey. It isn’t that E.S.G. investing has waned in popularity, Lisa Woll, the former head of US SIF, said in an interview. “The industry has matured,” she said. “It’s time that we be more careful and more precise.”

Labor Department Rules

Pressure on the E.S.G. industry mounted during the Trump administration, when the Labor Department was headed by Eugene Scalia, a son of the Supreme Court Justice Antonin Scalia and, like him, a skilled lawyer with a conservative, pro-business and anti-regulatory focus. The Scalia Labor Department instituted rules that made it harder for the people who run workplace retirement plans to include E.S.G. funds among workers’ investment choices.

The rules had “provisions that stakeholders viewed as discouraging fiduciaries from exercising shareholder rights” in corporate proxy fights, according to Mercer, the benefits consulting company.

The Biden administration overturned the rules, and Congress has tried to reverse the Biden versions, which remain in effect. Republican efforts to block the rules are underway in the courts. It’s dizzying.

The fierce opposition could impede the expansion of E.S.G. investing and proxy voting in retirement plans. The effects on voting haven’t been widely emphasized but they are consequential.

That’s because investors — including pension funds — increasingly keep their money in indexed investments run by the biggest fund companies, including Vanguard, BlackRock and State Street. Many funds track broad markets and own shares in nearly every public corporation, where they are typically the biggest shareholders.

Their votes can be decisive. But they have frequently sided with corporate managements and, until recently, rarely asked shareholders what they actually wanted. But now, all three companies are conducting experiments in “pass-through voting” that could give shareholders a greater voice. In a recent report Morningstar said these experiments were “likely to have an impact on voting trends in coming proxy-voting seasons.”

That won’t happen if opposition to E.S.G. investing stops shareholder democracy in its tracks in workplace retirement plans.

It’s sometimes said that everything is political. I wouldn’t go that far, but it’s increasingly obvious that investing is.

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