Study finds government, not investor returns, fuels ESG fad

In 2022, Oklahoma state lawmakers approved the “Energy Discrimination Elimination Act,” which requires the office of the state treasurer to conduct a review of investment firms to identify those that boycott investments in oil and gas companies regardless of the impact on investment returns. State entities cannot contract with firms on that list.

A lawsuit filed this year has resulted in a temporary injunction that keeps the law from being enforced. The plaintiff in that case argued his state pension benefits could be harmed if Oklahoma pensions do not invest in the funds targeted by the law—those that prioritize so-called “environmental, social, and governance” (ESG) policies.

But a new study shows that ESG investment is not pursued because it produces better returns but is instead largely the result of government pressure to promote ESG goals.

“ESG Investing: Government Push or Market Pull?”—by Allen Mendenhall and Daniel Sutter, two professors at Troy University—states, “We do not deny that many investors across the globe are interested in ESG as opposed to only private returns. However, the breadth and depth of government action are clearly pushing more investors into ESG.”

In a related column, the two men note, “In a level playing field, ESG-weighted portfolios struggle against market-tracking index funds, which provide better diversification and risk reduction.”

So, if better returns are not produced by ESG investing, why are so many institutional investors engaged in it? Because government policies are pressuring investors to dump money into those less-profitable markets, the report suggests.

Mendenhall and Sutter identify numerous government actions driving ESG, including policies mandating an energy transition; promulgating laws, rules, and directives compelling ESG reporting; and providing generous tax incentives and financial subsidies to favored industries.

For example, the Paris Climate Treaty, which has been formally adopted by the European Union (EU), sets a target of a 55-percent emissions reduction relative to 1990 levels by 2030. European Climate Law also commits the EU to be net zero by 2050. Australia has committed to a 43-percent emissions reduction from 2005 levels by 2030. And in the United States, the Biden Administration has rejoined the Paris Agreement and set a goal of 50 to 52 percent emissions reduction by 2030.

The report notes that the United States has also “enacted a series of additional government mandates to force an energy transition.” Among those policies, the Biden Administration wants 50 percent of new car sales to be electric vehicles by 2030, the federal Environmental Protection Agency (EPA) has proposed emissions requirements that critics say will effectively ban new gas-powered cars, proposed EPA emissions requirements for electric utilities could force the closure of many coal-fired power plants, and natural gas stoves and appliances have been targeted for elimination by various proposed government regulations.

Twenty-nine states also have renewable portfolio or clean-energy standards that mandate the creation of new wind-power and solar-energy generation, which is less dependable than fossil-fuel-powered electricity generation. Of those 29 states, 17 have set a goal of having 100 percent of electric power generated by renewables.

In addition to causing money to be diverted to ESG funds rather than into productive use elsewhere, the rhetoric surrounding the adoption of those environmental policies is at odds with reality, the report notes.

“Economics is not driving the clean energy transition,” Mendenhall and Sutter write. “The U.S. Energy Information Administration in a projection of U.S. energy use in 2050 still expects 75 percent to come from fossil fuels despite government mandates.”