The End of the Old ESG
Making sense of what investment stewardship could look like in Trump’s return
By Sahand Moarefy, corporate attorney and author of The New Power Brokers: The Rise of Asset Manager Capitalism and the New Economic Order
In the weeks leading up to President Trump’s inauguration, policy wonks and business leaders have been eagerly jockeying to shape the next administration’s economic agenda. Amidst this frenzy, one topic that warrants greater attention is the future of the Environmental, Social and Governance (ESG) movement, which calls on investors to prioritize environmental and social issues—like climate change and diversity—when making investment decisions.
ESG investing experienced a surge in growth in the last half of the 2010s through the COVID-19 years, fueled partly by a surfeit of cheap money and a general zeitgeist of progressive social activism. Since then, ESG’s popularity has dramatically receded as choppy macroeconomic factors have pushed investors to reemphasize conventional financial metrics for business performance, while many of the institutional investors at the forefront of the ESG movement have become the target of heated attacks from conservatives who view ESG as a Trojan horse for advancing liberal policy objectives. In the first half of 2024, the U.S. ESG market experienced net outflows of over $13 billion, on the heels of a $9 billion outflow in 2023, which marked the first time more sustainable funds liquidated or removed ESG criteria from their investment practices than were added. Obituaries of ESG – with headlines like “The Rise and Fall of ESG”, “Is ESG Investing Dead?” and “ESG is on its way out”—are ubiquitous in business journals and media outlets.
While it is undeniable that ESG is no longer the substantial force it was a few years ago, rumors of ESG’s demise are greatly exaggerated and overlook the nexus between ESG and deeper structural changes in our capital markets that remain persistent with us to this day. As I describe in my new book, ownership of corporate equities has shifted from individual shareholders to large institutional investors over the last 70 years, with asset managers now owning approximately 80% of corporate shareholdings (as compared to 6% in 1950). Unlike the prototypical mom-and-pop investor of yore, these asset managers are broadly diversified investors, often holding equity investments in virtually all U.S. public companies and better thought of as investors in the wider economy, rather than a circumscribed list of companies. Particularly in the case of index funds, which by some accounts represent as much as 33% of total U.S. stock market capitalization, asset managers are custodians of permanent capital, investing without the option of increasing or decreasing their positions in specific companies unless the composition of the relevant index changes. In turn, those equity investments are funded by the 401(k) accounts and retirement assets of regular Americans, the vast majority of whom are not looking to cash out until they hit retirement age.
ESG originally emerged as a response to these changed dynamics in our public markets. Many conservatives today view ESG to be a front for liberal environmental interests and other progressive causes, but ESG’s earliest supporters by and large espoused broader objectives that cannot be fairly characterized in purely partisan terms. Advocates argued that diversified long-term investors had to consider both the individual business profiles of the companies in which they invested, as well as systematic risk factors that are not traditionally perceived to have financial significance and yet may impact overall portfolio returns. When the ESG argument was first outlined in a 2004 United Nations white paper entitled “Who Cares Wins?,” the authors did not purport to offer an exhaustive list of what those systematic risk factors may be. In the aftermath of the Great Recession, the ESG agenda increasingly became re-oriented around environmental and social issues of a largely liberal political valence as institutional investors and businesses came under pressure from progressive activists looking to extract their pound of flesh from corporate America. That trend was turbocharged by Obama-era Department of Labor regulations and later the Biden-era SEC, which catalyzed ESG activism by issuing guidance that empowered activists to lob environmental and social proposals at companies without having to demonstrate the economic impact or relevance of those proposals.
Despite the ultimate trajectory of ESG’s evolution, the fact remains that conventional notions of shareholder value do not carry the same salience in today’s financial landscape. Investment frameworks must be developed that deal with the reality that the substantial bulk of money flowing into public equities is locked-in capital that institutional intermediaries are channeling on behalf of regular working people as investors in the aggregate performance of the economy.
The politicization of ESG over the last decade has unquestionably been a legitimate focus of criticism for conservatives, but to expect that diversified investors will put on horse blinders to the systematic risk factors that impact their portfolios is untenable. It also risks ceding more ground to political activists who have less inhibitions about the dividing line between politics and business. Although the ESG acronym may not be as popular today as it was a few years ago, the underlying themes at the heart of the movement continue to surface in public company shareholder proposals, and remain a common subject of discussion in investor and corporate governance circles.
Ignoring the demand among large, diversified institutional investors for investment frameworks that are customized to their needs just means that those investors will only have ESG (or ESG-like) frameworks to look to. It is worth remembering that “Who Cares Wins?” was published at a time when Republicans controlled all branches of the federal government and the then-fresh memory of the 9/11 attacks was spurring a general rightward shift in American culture. As conservative writer Julius Krein has pointed out, the progressive version of ESG that eventually came to dominate mainstream corporate-governance discourse acquired its dominance in part because of an unwillingness among those with more moderate or conservative political sensibilities to offer an alternative vision to address the real world investing dynamics that ESG purported to tackle.
The time is ripe for a new paradigm of investment stewardship that directly engages with today’s unique investor dynamics while avoiding the political minefields that have been responsible for much of the public controversy surrounding the ESG agenda. The Trump White House can lend a hand to this effort in two important ways. First, the new administration should roll back regulatory initiatives that have spurred much of the politicization of ESG over the last decade. Chief among these is the panoply of climate change disclosure rules that have been foisted on companies by the SEC over the last four years and SEC Staff Legal Bulletin No. 14L, which created special exceptions for ESG activists to pressure corporate management through the proxy voting process.
Beyond these immediate reactive measures, the administration should think about the long term and do what it can to help support the development of a pro business-minded alternative to ESG. Rather than resort to the type of regulatory heavy-handedness that has come to be associated with ESG advocacy, the White House is uniquely positioned to take on the role of facilitator in helping foster a constructive conversation among corporate executives and investors about what values and priorities should underpin an alternative paradigm, with a focus on addressing issues that have often been overlooked or minimized to date.
First and foremost is the importance of energy resiliency. While ESG activists may be correct in asserting that environmental crises like climate change can impose costs on businesses, those costs must be weighed against the tangible costs associated with taking overly aggressive measures to combat environmental challenges, particularly with respect to the availability of cheap energy. Overlooked in today’s environmental focus is that plentiful and affordable energy is a prerequisite to a vibrant economy that works for the benefit of shareholders and other stakeholders, especially the working-class and middle-income people who bear the brunt of higher energy prices everywhere from the gas pump to the grocery store. It may be sensible to view environmental risks as economic risks in certain circumstances, but that should not automatically translate into a disregard of the necessity of maintaining a robust and thriving energy economy. Policy measures that support energy production, such as approving new export licenses for LNG and expediting drilling permits on public lands, should be welcomed rather than discouraged by investors.
Attention should also be paid to how companies and investors decide to engage on hot-button social issues, such as abortion rights and diversity, which have been a particular flashpoint of controversy in the public debate about ESG. In recent years, many businesses have found themselves unwittingly dragged into culture war debates as a result of pressure campaigns from external political activist groups as well as politically active employees and customers. Any new investment stewardship paradigm should give appropriate deference to executives in their efforts to avoid the fracas that frequently accompanies these debates and recognize that irrespective of one’s individual stance on the underlying topics that motivate activist campaigns, it is just as appropriate for executives to exercise caution and consider the varying perspectives of their broader base of less politically active corporate constituencies before deciding whether to take action or make a statement on a given social issue. Whatever level of zeal certain employees or customers may bring to bear to the culture wars, companies should feel they have the flexibility to consider the more general social consensus that holds among their stakeholders before wading in.
Finally, there ought to be a greater focus on both the opportunities and risks stemming from the globalized nature of American business. International supply chains, which have become more and more attenuated over the last half-century, can give rise to informational blind spots and vulnerabilities that hurt the bottom line and consumers, a fact that became painfully evident in the spring of 2020 when the outbreak of COVID-19 gave rise to sudden shortages across economies. Likewise, geopolitical risks also call for greater consideration, especially as they relate to China and the dependencies of the American economy on Chinese manufacturing. Outsourcing of labor and other production inputs may allow for reduced overhead in the short-term, but investors should also examine the long-term ramifications of business activity moving to countries whose governments may have different interests and models of economic governance than the United States. Whatever investment stewardship paradigm replaces ESG should confidently speak to these and other macro risks, rather than solely fixate on correcting for the problems endemic to ESG.
The future of any alternative investment stewardship framework is ultimately for market actors to decide. All that policymakers can do is help set the stage for a healthier, less politically divisive discourse among relevant stakeholders as to what the future will look like. Hopefully, with the new administration having entered the White House this week, we can begin turning the page toward that future.