The Politics of Values-Based Investing

Robert Eccles is Visiting Professor of Management Practice at Oxford University Said Business School and Jill E. Fisch is the Saul A. Fox Distinguished Professor of Business Law and co-Director of the Institute for Law and Economics at the University of Pennsylvania Carey Law School.

Related research from the Program on Corporate Governance includes The Illusory Promise of Stakeholder Governance (discussed on the Forum here) by Lucian A. Bebchuk and Roberto Tallarita; Does Enlightened Shareholder Value Add Value? (discussed on the Forum here) by Lucian A. Bebchuk, Kobi Kastiel, and Roberto Tallarita; Companies Should Maximize Shareholder Welfare Not Market Value (discussed on the Forum here) by Oliver Hart and Luigi Zingales; Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee (discussed on the Forum here) by Max M. Schanzenbach and Robert H. Sitkoff; and Exit vs. Voice (discussed on the Forum here) by Eleonora Broccardo, Oliver Hart and Luigi Zingales.

Senate Republicans are introducing legislation directing retirement plan sponsors to select investments solely based on monetary factors, an extension of the position adopted by the Trump Administration Department of Labor. The sponsors to the legislation defend it by arguing that retirement accounts should be off limits to politics. The debate stems from the increasing criticism of pension and mutual funds that incorporate environmental, social, and governance (ESG) factors into their investment policies.

In challenging investment managers’ focus on ESG data, however, critics conflate two distinct issues. A body of empirical literature makes the claim that ESG data is relevant to evaluating a company from an economic perspective. We term this a “value-based ESG strategy.” For example, portfolio managers may invest in companies that they believe face strong growth prospects because they have products to help in the mitigation and adaption of climate change, or in companies that have strategies which will enable them to transform their business models in the fact of climate change. This is a value-based strategy. Of course, this assumes a particular perspective on the risks associated with climate change—one can argue that climate change is not real or that, even if it is, regulators will not impose costly changes on companies. The point, however, for such portfolio managers climate change is an economic risk, and their incorporation of climate-related data is a value-based investment strategy.

Investors who believe you can make money by investing in companies that are addressing this problem can invest in the BlackRock Future Climate and Sustainable Economy ETF (BECO). Notably, BECO purports to be investing for value, not values, stating that it “seeks to maximize total return by investing in companies that BlackRock Fund Advisors (“BFA”) believes are furthering the transition to a lower carbon economy.” Similarly Morgan Stanley touts its sustainable equity funds as outperforming their traditional peer funds.

In contrast, Senate Republicans’ real concern appears to be investments that employ values-based strategies—that is, investing according to a set of principles irrespective of any link between those principles and economic value. An example of a values-based fund is the S&P 500 Catholic Values ETF (CATH). As the fund’s prospectus explains, “The S&P 500 Catholic Values Index applies exclusion criteria to the constituents of the S&P 500 in order to create a benchmark aligned with Catholic values. These values are consistent with the Socially Responsible Investment Guidelines outlined by the United States Conference of Catholic Bishops (USCCB). The index is designed for investors who wish to track a benchmark that is consistent with USCCB guidelines.” Notably, the fund’s website contains an explicit disclaimer about the risks of a values-based strategy: “CATH’s consideration of the Guidelines in its investment process may result in choices not to purchase, or sell, otherwise profitable investments in companies that have been identified as being in conflict with the Guidelines. This means that the Fund may underperform other similar funds that do not consider the Guidelines when making investment decisions.”

Concededly, the line between values-based investing and value-based investing is unclear, and few funds are as explicit in disclaiming the link as CATH. At the same time, many such funds are explicitly marketed as tools by which investors can invest according to their values. As a result, it may be difficult for investors to determine whether they are foregoing economic value when they invest in an ESG fund.

For example, on September 6, 2017, Point Bridge Capital, LLC launched the “Point Bridge GOP Stock Tracker ETF,” now called the “Point Bridge America First ETF,” with the ticker symbol of MAGA. In large and bold letters the homepage of the website for the fund states: “Bring Republican Investment Values to Life by Investing in the MAGA ETF.” The website explains Politically Responsible Investing® as “allow[ing] people to invest in companies that align with their Republican political beliefs.” The MAGA Index is made up of “the top 150 companies from the S&P 500 Index whose employees and political action committees (PACs) are highly supportive of Republican candidates.” MAGA is thus a good example of values-based investing.

Notably, nothing in MAGA’s fund materials purports to tie its investment strategy to economic value. Rather, the underlying rationale for the fund is that:

Money matters in politics, affecting elections and the creation of policy in Washington. Corporations continue to take political stances and actions that ignore the political beliefs and shared values of millions of Americans. The left is using corporate America to silence conservatives and promote their agenda. While some people have boycotted companies with whom they disagree, they remain invested in these companies in their mutual funds and stock portfolios. We have created the MAGA ETF as a solution to these issues.

CATH and MAGA illustrate that responsible investing is not limited to left-leaning funds. In essence, each is a form of “Socially Responsible Investing (SRI),” just based on a different set of values for the screening process. The current rabid debate about ESG investing has its origins in SRI. While SRI can be traced back some 200 years to the Quakers, it can be said to have formally begun with the launch of the Pax World Fund (which still exists) in 1971 that by two “United Methodist ministers—Luther Tyson and Jack Corbett—looking to avoid investing church dollars in companies contributing to the Vietnam War, founded the ground breaking Pax World fund.” The original SRI funds, created for religious groups, screened out “sin stocks” like alcohol, firearms, gaming, and tobacco. Thermal coal, especially, and oil and gas are increasingly on the list for exclusion. Proponents of negative screening also often make the argument that this will put pressure on these companies to change, or even go out of business, by raising their cost of capital. This is a highly researched topic but a recent working paper with one of us as a co-author suggests that negative screening has no effect on the returns of sin stocks.

Although SRI started out on the left, it is now, somewhat ironically, being incorporated by the right. A March 26, 2021 Wall Street Journal article starts by saying “Values-based investing options for conservatives have lagged behind those available to investors concerned about climate change, diversity and animal rights.” It notes with satisfaction that “conservatives are taking a page from liberal investors.” Perhaps unwittingly, the WSJ is bestowing legitimacy on the use of SRI to influence company behavior, particularly when it is combined with strong shareholder engagement with the company’s board of directors and senior management. It’s just that what is “socially responsible” is a function of one’s political views.

The appeal of values-based funds—on either side of the political spectrum—is that people can invest their money in companies they think are living values they care about. For example, the SPDR® SSGA Gender Diversity Index ETF “seeks to provide exposure to US companies that demonstrate greater gender diversity within senior leadership than other firms in their sector.” State Street does not claim to be seeking “outperformance,” and there is a body of empirical research showing shows that more diverse groups make better decisions. But it is unclear whether State Street is seeking to market its fund in terms of economics or to those who are seeking a values-based strategy incorporating diversity.

Animal rights is perhaps more obviously a values-based approach. Those with this investment conviction can invest in the US Vegan Climate ETF (VEGN). “Through its passive rules-based approach VEGN seeks to avoid investments in companies whose activities directly contribute to animal suffering, destruction of the natural environment and climate change.” VEGN makes no performance claims, but it is conceivable that those companies for which this is an issue will attract better people and more customers.

A separate question is the extent to which values-based funds behave in a way that is consistent with their marketing. Recent articles, for example, have challenged so-called green funds for not living up to their claims because they hold investments in energy companies. The analysis is difficult, however, in part because there is no universal definition of ESG. Similarly, reasonable people can disagree on what investments are consistent with any values-based investment strategy. Again, consider the MAGA fund. MAGA is based on an index which “uses an objective, rules-based methodology” to identify Republican-friendly companies in the S&P 500® Index, defined in terms of campaign contributions and having at least 50% of their assets in the U.S.

Whether MAGA’s holdings can fairly be characterized as “companies that align with your Republican political beliefs” is less clear. At present, MAGA’s largest holding is Constellation Energy which proudly says on the homepage of its website: “Constellation is now America’s LEADING CLEAN ENERGY COMPANY! We’re the nation’s leading provider of carbon-free energy and are committed to being 100% carbon-free by 2040.” Another company in its top 10 holdings is NextEra Energy which states that, “A REAL PLAN FOR REAL ZERO. NextEra Energy has a plan to lead the decarbonization of America.” The homepage of its website also features its “2022 Environmental, Social, and Governance Report.” There is not a single major oil & gas company in MAGA’s top 10 holdings. This suggests that Republican values aren’t necessarily inimical to recognizing the reality of climate change and the opportunities to make money in addressing it. Indeed, it would appear that both companies would be appropriate holdings for the ESG funds spurned by Republicans.

A final concern is that investors may lose money by investing in values-based strategies. There are two main criticisms of SRI. The first is that negative screening reduces diversification and thus increases risk and suboptimizes returns. The second is that exclusion of “sin stocks” may be leaving money on the table. There is no empirically conclusive evidence that negative screening hurts performance as shown by the 30-year history of the MSCI KLD 400 Social Index vs. the MSCI USA Index. The market value of MAGA’s shares is down by 11.04% since inception (the S&P 500 is up about 72.88% in the same period of time). By comparison, the shares of CATH are up by around 11.67% since inception and 10.72% over the past five years, the shares of SSGA Gender Diversity Index ETF are up 8.95% since its inception on March 7, 2016, and the market price of VEGN is up 9.96% since its inception on September 9, 2019.

The experience of a specific values-based fund does not, of course, condemn a values-based investment strategy. We also note that many of the values-based funds, both those on the left and those on the right, have expense ratios that exceed industry norms, and expense ratios are one of the most important drivers of fund returns. The expense ratio for the MAGA fund, for example, is 0.72 %, the expense ratio for BECO is 0.70%, and the expense ratio for VEGN is 0.60%, MAGA’s expense ratio seems particularly high in that MAGA a passive fund. According to the latest Morningstar report on fund fees, the average for a passive U.S. equity fund like MAGA is 0.08%. The report also notes that fees for passive funds have fallen about 25% since 2017 and states that “The downward pressure on fund fees is unlikely to abate.”

Whether a values-based strategy underperforms, however, is not the point. In values-based investing, people should be free to invest their money however they want, even if at a potentially lower risk-adjusted return. The real problem is that values are obviously in the eye of the beholder and what is value investing for one person may be perceived as values-based investing by another. This is what is at the heart of the current controversy over ESG investing in terms of criticisms from the Right. If some people do not believe climate change is real, that is their point of view. But it goes too far for them to call a value-based climate strategy a values-based one. Nor is a fund that loads up with oil and gas stocks to seek outperformance engaging in a values-based strategy.

We do not expect the controversy about ESG investing to disappear anytime soon. Much of it is healthy, such as correcting for excessive claims that an ESG fund “will make the world a better place” when there is no demonstrable way to show that it will. Conservatives who complain that ESG investing is a way of forcing a social and environmental agenda on companies that has nothing to do with company profitability, perhaps even hurting it, need to look in the mirror if they are creating anti-ESG funds of their own. This is simply swapping out one set of values for another. Both are forms of Socially Responsible Investing.

We also suggest that those buying into these funds look carefully at the holdings. Do the companies in the fund really reflect the values the fund is claiming to support? Just as those concerned about climate change are unhappy when they find an ESG or climate fund owns shares in an oil and gas company, those who have invested in MAGA need to decide if Constellation Energy and NextEra Energy truly reflect their Republican values—even if these companies are major donors to the GOP. Whether on the left or right end of the political spectrum, it is unlikely one can find a fund that ticks every values box.

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  1. Mark J. Guay
    Posted Wednesday, September 7, 2022 at 5:01 pm | Permalink

    The whole point of ESG proposed “metrics” today is to get beyond the fuzziness of SRI “values” definitions of yesterday. This is precisely what the IFRS, the ISSB and the SEC are working on in 2022, viz.; what the “metrics” will be going forward, and thereby to get beyond marketing and academic conflations of same with SRI in the past. To ignore all the proposed drafts rules and the hard work by these international organizations and government agencies in the past year in this article is not helpful by instead debating “value versus values” based investing. Investors actually are driving the ESG climate-related new metrics. The only issue now is WHAT type of ESG information, and HOW much decision-useful information, is needed to make informed decisions on risk. Time to move forward.

  2. Mark J. Guay, PC
    Posted Thursday, September 8, 2022 at 9:44 am | Permalink

    The debate in 2022 is all about what “metrics” should the IFRS, the ISSB, and the SEC approve in upcoming regulations regarding ESG related issues – due out as early as December this year. The “values vs. value” difference is thereby set aside in the past SRI debate, because all parties have either proposed or commented on the drafts of the new metrics, regarding what precisely those will be. And the biggest drivers of the 2022 climate-related metrics are investors themselves who want to better understand their risks. As the old adage goes, “you can’t manage what you can’t measure”, so the measurements are in process and these metrics are due out soon.

  3. Hal Lambert
    Posted Thursday, September 8, 2022 at 11:45 am | Permalink

    So typical of academic Marxists, you put out blatantly false data that I’m sure will be corrected at some point as a “mistake”. The MAGA index is up 70.35% since inception. It is not down 11%. Anyone with a brain could have caught that “mistake” with it being illogical during a 5yr bull market. The fund is equally weighted so a “top 10” doesn’t really mean much. The sector weightings are much more important. It is double the weight of the S&P in oil/gas. And regardless of what companies “say” on their websites, its where they give their dollars that matter. Almost all corporations put out left wing talking points because they think it will placate the left who attack them daily. It of course won’t placate them. ESG is a scam that actually hurts earnings and competitiveness. Investors are finally starting to figure it out as the tide of a recession exposes the wasteful nonsense. Good luck with your future research endeavors, you might want to take a math class before your next project.