Nowadays, it seems nearly impossible to avoid the headlines about environmental, social and governance investing. More recently, the drumbeat of detractors has grown louder, positioning it as a framework that’s inextricably linked to an activist political agenda. As a result, the financial services industry has lost sight of the movement’s original intent.
The term “ESG” first entered the lexicon thanks to the work of the United Nations Environment Programme Initiative. These efforts were not driven by an activist agenda; rather, it was asset owners and managers who recognized the link between environmental, social and governance actions and shareholder value. At its core, ESG is (and always has been) about assessing corporations based on their exposure to and management of financially material environmental, social, and governance risks.
Pragmatic investors, regardless of their values and political inclinations, should want more information about how the companies in their portfolios affect–and are affected by–the world around them, given these risks carry very real financial ramifications. Ironically, agenda-driven politicians are therefore arguing against prudent investing. Here are three examples—spanning the environmental, social and governance categories—that illustrate this point further:
In recent weeks, Norfolk Southern Railway has made headlines for all the wrong reasons. The large railway company attracted public scrutiny after a train derailment in Ohio caused a massive chemical spill, contaminating the community’s soil and water and endangering residents’ health. Norfolk Southern now faces investigations into its safety practices and handling of hazardous materials–clear risks that predated the disaster itself and to which many ESG investors were able to limit exposure.
The company’s expenses amount to more than elevated crisis communications retainers. In February, Norfolk Southern Railway was notified by the Environmental Protection Agency it will be responsible for cleanup costs associated with the derailment. The company is also facing mounting class action lawsuits and is likely to be held liable by insurers for more damages. Norfolk’s biggest investors? Vanguard and BlackRock. Everyday investors may be more exposed to this disaster than they think. Ironically, some of the same politicians arguing to abolish ESG have publicly called out the company’s failure to manage these (clearly ESG-related) risks.
Banking multinational Wells Fargo famously endured severe reputational damage after opening millions of unauthorized bank accounts in customers’ names and selling them insurance they didn’t need. Subsequent investigations revealed fraudulent practices and a culture of aggressive sales tactics across multiple lines of Wells Fargo’s business, causing the Federal Reserve to take bold action and levy a cap on the bank’s asset growth.
Though Wells Fargo stock didn’t drop precipitously when news first emerged about the bank's unscrupulous activity, it has since underperformed relative to its peers. Further, regulatory agencies have levied various fines totaling billions of dollars, with the CFPB asserting that “Wells Fargo’s rinse-repeat cycle of violating the law has harmed millions of American families.” Many ESG investors were disheartened by these actions, but not down and out–Wells Fargo’s poor ranking on social factors was already known to them and they were able to minimize exposure before this string of crises unfolded.
While Tesla's environmental credentials are largely robust, most ESG investors like to consider the full picture. And Tesla shareholders have not welcomed CEO Elon Musk’s decision to purchase Twitter or his personal behavior on the platform. In 2022, Tesla stock cratered 65%, marking a record annual decline and wiping $700 billion off the company’s valuation. While some of this can be attributed to supply chain snarls and other factors, various onlookers have expressed concerns that Musk’s unpredictable actions are tarnishing the carmaker’s brand and exacerbating its woes. Supporting this point: on March 8, Tesla stock endured multi-session losses after Musk spoke disparagingly about a recently laid-off Twitter employee.
Erratic tweeting aside, attorneys for a Tesla shareholder just this month argued that a compensation package of $55 billion or more, awarded to Musk as chief executive officer, be invalidated. These attorneys allege that the package was “dictated by Musk and the product of sham negotiations with directors who were not independent of him ... it was approved by shareholders who were given misleading and incomplete disclosures in a proxy statement.” Once again, shareholders clearly view strong corporate governance structures as material to shareholder value.
Today’s 24/7 news cycle and social media access mean we have more information and visibility than ever before concerning companies’ actions and their associated risks. This means we will continue to see headlines about ESG, and the various ways corporate missteps drive measurable financial outcomes. Advisors and consumers would do well to look beyond the noise and remember this: Stock values are based on what we, the collective of retail investors, think and feel. ESG values are based on corporate risk mitigation.
Financial advisors have a fiduciary duty to their clients and, by eschewing ESG factors, may be overlooking threats and opportunities that stand to affect their clients’ returns in the long term. The ability to connect with clients on a deeper level, and tailor offerings to their preferences and causes they care about, just happens to be a positive side effect.