A Reset Moment for ESG Investing?

After two years of unprecedented growth, ESG-focused investment funds are having a reset moment. 

The backlash against asset-management firms that base investment decisions in whole or in part on ESG principles, particularly with regard to so-called “green investing,” may be reaching a tipping point as 2023 begins. Recently, for instance, the world’s largest mutual-fund manager withdrew from a major industry-led net-zero investing initiative in which nearly 300 asset-management firms are seeking to achieve net-zero portfolios by 2050. States—among them, North Carolina, Florida, Louisiana, and Texas—have jumped into the anti-ESG investing fray, calling for the removal of fund leadership or threatening to pull money from ESG-focused funds. 

Such changes are unlikely to affect corporate ESG efforts immediately. But experts say they could shape longer-term plans, particularly if similar proposals are made at annual shareholder meetings. Investors could also nominate new board members. “Investors are beginning to feel real pain,” says Chad Astmann, co-head of Korn Ferry’s Global Investment Management practice. Kate Shattuck, co-leader of Korn Ferry’s Impact Investing practice, says she sees serious headwinds for ESG-focused funds. “This year is going to be a big test for funds and strategies labeled ESG to outperform,” she says. 

Put another way, investors’ attitudes towards ESG investing have changed with the economic environment. When companies were growing and returns were good, investors were more than happy to pour money into ESG funds—more than $32 billion over the last two years, to be exact. But now that growth has stalled and a recession is looming, stockholders are looking more closely at where and how their money is being invested. In 2022, for instance, less than $5 billion was invested in ESG-focused funds. Astmann says investors are “rebalancing their moral allegiances to ESG” to meet financial needs. Many ESG-focused funds were forced to close last year; today, those that are publicly traded are underperforming other mutual and exchange-traded funds. 

Poor financial performance isn’t the only factor at play. The politicization of green investing, along with more stringent regulatory disclosure rules, is causing firms to rethink the “one-size-fits-all approach” to ESG principles, says Astmann. In the heat of the purpose movement, he says, some asset-management firms went all in on ESG investing, as much for competitive reasons as out of concern for the planet. “Investment managers shifted their marketing narratives and investment engines to accommodate what appeared to be a permanent and wholesale change in the industry,” says Astmann. “In the process, they dispensed with the need to balance all stakeholder interests.” He notes that the firms that took a more balanced view of ESG with “incremental leaning in” are having an easier time responding and adjusting to the market downturn. 

Experts agree, however, that the current environment is more anomaly than trend for ESG-based investing. For one thing, the backlash against ESG investing is coming from a small but loud minority that doesn’t represent the vast majority of business leaders, employees, customers, and investors, says Anthony Goodman, a senior client partner for ESG and leader of the North American Board Effectiveness practice at Korn Ferry. “It’s performative nonsense,” says Goodman, who asks where the states threatening to pull out of ESG-focused funds are going to invest the pensions of their retired employees. As for the financial performance of ESG-focused funds, Goodman points out that the decline in returns is driven by two factors beyond fund managers’ control: the pummeling of tech stocks, which are typically overweighted in ESG funds, and the rise in energy stocks, which are underweighted. 

Moreover, companies themselves aren’t backing away from net-zero emissions or other environmental initiatives, says Shattuck. What’s changing, she says, is that companies and investors are getting more precise about the risks and opportunities around ESG, as well as about the data and metrics they are using to measure what’s material to individual firms. “When we look back on this year, it will end up being a proving point of ESG-focused investing,” she says. 

Read more This Week in Leadership articles