ESG pseudo-science gets brutally debunked

Many states have passed legislation to protect their economies and their retirees, requiring that public funds be invested with financial institutions focused solely on financial performance, not environmental, social and governance or "ESG" goals.

ESG activists oppose such laws. They would prefer to steer investments toward favored causes and away from disfavored ones, such as fossil energy producers and gun manufacturers.

When confronted with retirees' rights to have their money managed to maximize returns, not for political causes, the ESG activists have a stock response. They typically cite two studies that supposedly showed increased costs from laws that rule out investing based on ESG concerns.

Fortunately, new analyses have debunked both of these studies. Both committed the classic fallacy of confusing correlation with causation, ignoring the fact that other states lacking such laws experienced the same cost increases due to broader market factors.

Around the time the Wharton School of Business launched a new “ESG Initiative,” an academic at the Wharton School released a study related to Texas laws prohibiting public contracts with finance companies that had committed to penalize energy companies or firearms companies. The study claimed that several banks had exited the Texas municipal bond market due to the new law, and asserted that municipalities had consequently been forced to pay hundreds of millions in additional borrowing costs as a result.

Notably, the Wharton study’s analysis covered just one eight-month period. As the authors later admitted, “the targeted banks partially re-entered Texas after that time.” The authors have also recently acknowledged that the reentry of banks less than a year after the laws’ implementation suggests two things: first, that the laws may have successfully incentivized banks to alter their ESG practices, and second, that the supposed negative impacts vanished after bank reentry.

Nevertheless, numerous articles have trumpeted the original finding from the Wharton study. A follow-up paper by a consulting group even used the Wharton study to estimate costs for other states considering or enacting legislation. The follow-up paper was conducted on behalf of ESG activist groups known as As You Sow and Ceres.

Fortunately, a new analysis from four academics at leading universities, released at a Brookings conference, has contradicted the Wharton study’s findings. It concludes that Texas municipal borrowing costs did not in fact increase as a result of the legislation. Although costs did increase during the eight-month period after Texas’s laws became effective, the new study points out that other low-tax states with similar bonds experienced the same increase in costs.

The implication is that the temporary exit of some underwriters from Texas was inconsequential. This suggests that “the underwriting business is quite competitive.”  In other words, the Wharton study showed correlation but failed to show causation. 

A similar scenario played out in Oklahoma. Oklahoma has long required fiduciaries of public pension systems to discharge their duties “solely in the interest” of the system. In 2022, Oklahoma passed a law requiring public entities to move away from investing with institutions that have additional goals of penalizing energy companies for their energy production. 

Oklahoma relies heavily on taxes generated from the production of oil and gas, collecting almost $2 billion from such taxes in fiscal 2023. However, that revenue has recently dropped to about half those levels. The state understandably ties this threat to its fiscal health and Oklahomans’ jobs to the efforts of ESG advocates such as BlackRock, which helped lead a Glasgow Financial Alliance for Net Zero commissioned workstream that called for the “early retirement of high-emitting assets” such as coal mines, oil fields and gas pipelines.

Rather than attempt to prove that ESG policies lead to better returns, ESG advocates once again retreated to the ivory tower, this time relying on an anonymously-funded and conveniently-timed study by professor Travis Roach. This study found that laws against ESG resulted in an increase in municipal bond costs.

However, recent analyses have revealed that the Roach study “has a pattern of cherry-picking data.” It also ignored that national and state municipal bond data show essentially identical interest rate increases to Oklahoma’s bonds as everywhere else. Once again, then, a study supposedly showing increased costs was mistaking correlation with causation and failing to control for other market factors.

ESG activists resort to these misleading academic scare tactics because they cannot win the argument about these laws on the merits.

The Texas and Oklahoma laws against putting retirees' assets at the mercy of ESG ideologies are part of a broad movement by more than a dozen states to return the focus of state pension investments to financial returns. Many states have adopted laws clarifying that public pension funds must be managed solely in the financial interest of the funds’ participants and beneficiaries.

These laws ultimately represent clarifications to existing law governing pension systems, which at the federal and state level has long required an exclusive focus on financial benefits.

Nor should these clarifications be controversial. Investment managers should have a singular focus on maximizing returns for their clients, especially when those returns fund state pension systems. And if investment managers are unable or unwilling to focus on financial returns, they do not need to accept public pension funds as clients. 

To avoid these conflicts of interest, financially focused public entities can switch to other financial institutions with zero or near-zero costs. For example, when Oklahoma’s pension system analyzed potential costs of shifting money from BlackRock and State Street — two firms that have committed to penalize energy companies in line with net-zero carbon goals — it found that five of the nine funds at issue “had zero or near-zero switching costs and bidders who had similar or superior fees and performance to BlackRock and State Street.”  

The long-term benefits of these moves are clear. Non-ESG funds have better returns than ESG funds, suggesting that asset managers who push companies to adopt ESG goals will drag down returns. Also, ESG initiatives to shut down coal and gas power plants, oil fields and livestock farms are bad for these states and bad for America.

With ESG’s academic scare-tactics debunked, what’s left is an unsurprising truth. Requirements that financial managers focus solely on financial returns is good for investors, good for energy security and good for the economy. 

Paul Fitzpatrick is president of the 1792 Exchange, an organization dedicated to advancing freedom by protecting small businesses and nonprofit groups and moving corporations back toward neutral.