Newly sworn-in Kansas State Treasurer Steven C. Johnson is taking a hard look at whether ESG (Environmental, Social, and Governance) policy influences pension fund investment — and who is managing the investments.
In recent years a new class of “activist” investors has arisen — and a new class of management funds run by them — which use not just “what is the best return on investment” to make decisions but also what they term “Environmental, Social, and Governance,” metrics.
According to Investopedia, “Environmental, social, and governance (ESG) investing refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments.
“Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.”
However, major ESG funds such as Blackrock have used the power of their checkbook to force changes to boards of directors at major companies such as Exxon Mobil.
Blackrock controls some $8.25 trillion in investments globally and is involved in nearly every state pension fund.
Johnson said one of his priorities is making sure that state pension funds are focused on the best return on investment — not ESG principles.
“The biggest investment pool that would have exposure would be the pension fund,” Johnson said in a phone interview. “The pension fund is around $23 or $24 billion … this is where we have exposure.
“The good news if you will, our domestic equity portfolio is entirely indexed or passive. So regardless, there are no active decisions being made on those ESG companies, And the international portfolio is actively managed and that one will take some more work to get through to see where those selection issues could be affecting us. But out of the gate, we don’t have any Blackrock actively managed funds that would be making those ESG decisions.”
However, Johnson said, Blackrock — or other similar funds like State Street or Vanguard may control “proxy” voting shares — where a shareholder has designated someone else to vote for them — in companies the state is invested in.
“Step two is critical, and that is getting a handle on how Blackrock is voting those proxy shares,” Johnson said, adding it was something he will be bringing up at the next pension board meeting. “That is one of the things we will be going over, and I will ask questions to make sure that they understand how those are voted. How are those proxy shares voted? How do we continue to do it efficiently? And how do we make sure that we are not promoting an ESG agenda through Kansas assets? We need to promote an agenda for the highest and best return of assets.”
The dangers of ESG investing to states
Derek Kreifels, CEO of the State Financial Officers Foundation, — of which Johnson is a member — says ESG funds, by restricting access to capital, can make it very difficult for companies, or individuals, who don’t score high on “ESG ratings,” to do business.
“(Blackrock) CEO Larry Fink has continued to make public comments, to push, you know, companies that not only help the way that they are managing funds, but they’re also leveraging companies that they invest in, frankly … for example, a cattle production company in Nebraska, and that company is not monitoring or engaged in some kind of what they would deem an appropriate level of methane mitigation, then they’re going to restrict the amount of investment that they have or allow them to be involved in a portfolio that they control or manage,” Kreifels said in a phone interview. “And so, you know, the implications for agriculture are enormous, whether it’s cattle ranching or wheat farming, that all of this is trickling down and impacting the price of diesel. It’s impacting the price of fertilizers. You can’t mass produce food for the world. Without fertilizer and pesticides and some of the chemical based products that we have to have to mass produce food.”
Moreover, ESG funds simply don’t perform very well.
Indeed, according to Harvard Business Review, as of Dec. 2021, ESG funds performed poorly over time, despite attracting more investment.
“Although the highest rated funds in terms of sustainability certainly attracted more capital than the lowest rated funds, none of the high sustainability funds outperformed any of the lowest rated funds,” the article states.
HBR also notes that: “while it is possible that investors would be happy to sacrifice financial returns in exchange for better ESG performance. Unfortunately, ESG funds don’t seem to deliver better ESG performance either.”
HBR further points out that: “Researchers at Columbia University and London School of Economics compared the ESG record of U.S. companies in 147 ESG fund portfolios and that of U.S. companies in 2,428 non-ESG portfolios. They found that the companies in the ESG portfolios had worse compliance records for both labor and environmental rules. They also found that companies added to ESG portfolios did not subsequently improve compliance with labor or environmental regulations.”
In a separate article, HBR notes that ESG funds are pricier, typically charging fees 40 percent higher than traditional funds and “All too often these higher fees are unwarranted given that ESG funds often closely mirror “vanilla” funds. Vanguard’s largest and longest standing ESG fund, its ESG U.S. Stock ETF, was .9974 correlated with the S&P 500.”
State-level legislation needed in Kansas
Johnson said he is working closely with new Attorney General Kris Kobach’s office to write legislation to help the treasurer’s office address any ESG issues with Kansas funds.
“One of the things that calls for is for the treasurer’s office to maintain a list of those (funds which) espouse ESG that we are using,” Johnson said. “And then, direct the pension boards to divest from those assets.”
Kreifels said his organization has two model policies they suggest states use, one is to strengthen the “sole fiduciary” role.
“Our argument from day one, when we started making noise about this nationally a year ago, is that any state investment fund, whether it’s a pension or short-term Treasury investment, or banking contract, or whatever it is, financially it should have one purpose when making an investment decision — and that’s the best return for the dollar for … the pensioner, or the taxpayer,” Kreifles said. “And that’s it, period. End of story. No other political issue should be used or leverage considered when making an investment decision.”
The other policy, Kreifels said, is to protect “signature industries” within a state from boycotts by investment firms.
“So basically (it would be a) bill that says, you know, if you are a company that has chosen to divest or to boycott, a specific industry,” he said. “If you’re engaged in anything that is destroying that signature industry for the state, then the state has every right as a market participant to say, ‘we’re not going to do business with you.'”
