On the latest episode of Nate Geraci’s ETF Prime, VettaFi’s Dave Nadig went in-depth on the state of ESG investing, including its recent politicization, advisor interest, fund company positioning, and how it impacts corporate behavior. Matt Piro, Global Head of ESG at Vanguard, explained the firm’s overall ESG philosophy, common misconceptions around performance, the importance of fund fees, and the challenge of no “one-size-fits-all.”
Geraci opened the show with an acknowledgment that some investors might be fatigued on the topic of ESG, but with a plea for people, particularly advisors, to challenge their priors and open their minds to learning more about a topic that is unlikely to go away anytime soon.
The list of challenges facing ESG these days is long. Geraci noted that, with traditional energy taking off, there has been some underperformance in ESG funds which are typically lighter on their energy exposure. Some ESG funds had exposure to Russia before the Ukraine invasion – which wasn’t the best look, and others are under scrutiny for China exposure. The political backlash has been especially potent, with some states divesting their retirement plans from energy or pursuing ESG initiatives.
Asked how politics got entwined in ESG investing, Nadig said, “it’s the other way around. ESG investing existed before it got as politicized as it has become. The reason it’s become politicized is because let’s face it, the current political climate is one that is largely based on culture wars, not policy decisions.” Nadig sees ESG as having become fodder for culture war conversations. “It is useful as a political tool because it is so ill-defined,” he observed.
Is ESG Losing the Narrative?
Given that advisors are taught to separate politics from their portfolios, Nadig wonders if ESG is “losing the narrative game” by becoming wrapped up in this discussion.
“I don’t think it’s a problem for ESG ETFs,” Nadig said, though he noted that investors have pushed the pause button of late on ESG ETFs, “we’ve seen the bloom come off the rose in terms of flows.” That said, Nadig also took care to point out that, “there’s still trillions of dollars still getting allocated around the world – particularly around the U.N. sustainable investment policies.” He thinks that the ESG slowdown was a uniquely American retail phenomenon until Texas and Florida decided to use ESG investing as a political football and pass laws and regulations around it.
With nearly half of respondents in a recent VettaFi survey saying that ESG was less than 5% of their assets, 20% putting it 5-10%, and 13% not having any at all, that means only 20% of advisors surveyed had more than 10% of their assets parked in ESG funds. Nadig wasn’t surprised by these results. “I think that is an accurate representation of where the average advisor market is,” he said.
Geraci wondered if firms like Vanguard and Blackrock are in a bind. “If they don’t present ESG initiatives, people are going to throw stones and say they don’t care about the world and those sorts of things,” he said, noting that on the flip side to this, these companies are some of the largest shareholders of energy companies in the world.
“If I’m a BlackRock or a Vanguard,” Nadig said, “and I’m in the business of putting product out there to meet investor demands, I think it is completely reasonable to have both your energy sector fund and a net zero fund, and have those things be part of the same lineup.” Nadig likened it to going into a Walmart where you can purchase diet aids in one aisle of the store and a large bag of Doritos in another with nobody arguing about them having to pick a side. “Nobody says a company should only have a growth fund and not a value fund.”
One key corner of the ESG debate has become proxy voting. Nadig observed, “we are now tying up the issue of voting into all of this. If you just look at how Texas has tried to regulate around this, it’s frankly ridiculous.” Texas made a lot of noise about passing legislation regulating ESG out of state pensions, but when you look at what the actual legislation is, Nadig noted that it’s just preventing those pensions from buying BlackRock stocks they didn’t own anyway, save through big index vehicles. “It’s entirely performative. It is all theater at this point,” continuing, “I think they are playing political football with people’s retirements and I’m not a big fan of that.”
Geraci brought up Strive, which he and Nadig see as an anti-Engine No. 1. Nadig is fine with the idea of picking a fund manager who will vote their shares. “If people want to vote with their pocketbooks and got Engine No. 1 because they want ESG activists on the Exxon board or they want to go to Strive because they want the most ‘drill, baby, drill,’ people to be on the board – I think that’s a choice that investors can make.” Where he draws issue with the discourse around this, is in the political maneuvering with the language that people use to describe their opposition here. Nadig said, “they make these claims about what ESG managers are doing or how they are voting which actually bear no reality whatsoever.” He also had a problem with charging high fees to run simple strategies and pocketing the extra change off of using a politically charged idea to drum up attention and support.
Nadig recently sat down with the Environmental Defense Fund’s Andrew Howell and Microsoft’s Matt Sekol for a robust exploration of the ground state reality of what it is like to be creating the systems and processes that make ESG work possible. “The real work here is being done at the face of the coal mine. It is not so much about whether Exxon should or should not exist. It’s a question of, ‘okay, Exxon is in the business of extracting oil. How do they do that in a way that minimizes the environmental impact of that activity?’”
Vanguard’s ESG Philosophy
For the second segment, Geraci was joined by Piro. Vanguard is the leader of ETF inflows this year, with $150 billion in inflows despite a challenging market environment. ESG has been an area of focus for Vanguard, with new ESG funds on the horizon and three ETFs on the roster already.
Speaking about Vanguard’s broad view of ESG, Piro said, “one thing that is clear is that there is increasing demand for low-cost high-quality options in the ESG space.” For Vanguard, Piro doesn’t think demand alone is enough to entertain launching a product or engaging on this. They need to have the conviction that these products can help investors achieve their long-term financial goals.
Piro said that when Vanguard launches an ESG product, “we’re going to be very clear and purposeful with the design of that product.”
He noted that, in a broad sense, it is important to think about the long-term risks companies can be exposed to, something that ESG funds can do. Being purposeful about what’s under the hood and offering education and thought leadership is critical.
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