Beyond ESG Funds: The New Wave of Value-Aligned Investing

Let’s start by clearing the air: Financial institutions recognize the demand for sustainability and responsibility. Public debate over the merits of ESG investing obscures the fact that the concept of managing risks related to environmental, social and governance concerns, just like other risks, is simply part of the game. The 2004 United Nations report that coined the “ESG” acronym made clear from the start that negotiating these issues is a component of “overall management quality needed to compete successfully.” The report was endorsed by 20 of the world’s largest banks and asset managers.

The branding of these risks spawned a market for similarly branded investment products. ESG funds pitch themselves, to varying degrees, as holistic baskets gathering companies that work and think alike on key issues. It’s a marketing tactic that signals responsible investment criteria as well as an investment thesis oriented around managing exposure to certain risks. These funds saw explosive growth around the dawn of this decade; at their 2021 peak the cumulative inflow into ESG equity funds topped $250 billion, per Barclays. They were an undeniable AUM spark across the industry.

Political discourse and overall market performance have arguably cooled the hype. At least 165 bills and resolutions seeking to bar ESG criteria in how public money is invested were introduced across 37 states in the first half of this year as Republican lawmakers characterized the investment philosophy as a symptom of so-called culture wars. The vast majority failed, not least because legislative analyses showed that such rules could lead to billions in losses, but some stigma stuck. Blackrock head Larry Fink, once a self-styled ESG evangelist, himself ditched the acronym, calling it “weaponized.”

The distance between how some investors understand these funds’ goals and how they actually  work may also be growing wider. A ominously titled Businessweek report in 2021 detailed how MSCI — the world’s largest ESG rating agency, which touted a better-world mission and assembles the indexes on which clients like Blackrock base their ESG funds — scores companies not on impact but on how ESG factors affect future business, lauding some companies even as their emissions rise. The ratings cottage industry has also created new conflicts of interest by consulting for the same companies it’s evaluating.

These tensions have produced branding rollbacks and, more consequentially, outflow. Global AUM in ESG funds fell year-over-year by around $163 billion in the first quarter of 2023, according to Lipper. One analysis found that 72 ESG funds closed this year, more than in the previous three years combined. The scale of decline and debranding is a matter of some debate — recent Morningstar data still showed 656 sustainable funds in the U.S. — but there is a clear uptick in asset managers “green hushing” their products.

The irony is that investors continue to demonstrate their interest in how companies engage with the world and its social and environmental risks. The number of shareholder proposals increased this proxy season for the third straight year. By at least one count, more directors failed to receive majority shareholder support this year than any of the previous five years, and participation in proxy votes by retail shareholders, who own a growing portion of outstanding shares, inched up. The largest asset managers have met an evolving demand for value alignment by starting to offer more clients new ways to influence how their shares are voted.

At Troop, we’re building the infrastructure for this next era of value-aligned investing. ESG funds represent a kind of passive strategy; they don’t require you to get your feet wet. But corporate governance is our collective responsibility, even if voting on directors and proposals remains daunting. Investors just need better tools. Our enterprise suite helps managers turn client and fund values into voting preferences, helps asset stewardship teams more efficiently execute directives, and more. Our shareholder activism app helps retail investors organize campaigns for change in their portfolios. Lend us your email below; we’d love to chat.