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>The ambiguity of the Environmental, Social, Governance (ESG) investment trend is leading to growing skepticism and potential legal woes for the movement. Many Democratic lawmakers and allies in the media are rushing to instead blame ESG’s fumbles on Republicans. For example, an op-ed on CNBC.com this month signed by Democratic senators Sheldon Whitehouse, Brian Schatz, and Martin Heinrich suggested that GOP skepticism of ESG investing is anti-capitalist. While there have been some instances of overreach by Republicans on this issue, the Left’s increasingly common line of attack — to equate ESG opposition to a distrust of free markets — is not only baseless but hypocritical. Recent underperformance by ESG funds have been the direct result of declining demand and risks inherent in ESG investing — not GOP lawmakers.
Republicans’ attacks on ESG aren’t anti-capitalist because nobody is getting in the way of institutions and private individuals voluntarily investing in ESG mutual funds. Free markets are characterized by parties knowingly agreeing to the exchange of goods or services, and this could be the case for ESG investments with appropriate disclosure to and consent from their shareholders. But conservative critics of ESG note that many individuals are contributing to such investments without their knowledge, particularly in their 401(k) accounts or pension plans. If market demand were as great as ESG proponents and Democratic politicians claim, such surreptitious investments wouldn’t be necessary. 
Perhaps Democrats’ concerns were driven by Vanguard’s December departure from the Net Zero Asset Managers (NZAM) initiative, an industry group committed to neutral-emission portfolios by 2050. Vanguard’s departure makes sense: 88% of the firm’s assets sit in products friendly to individual investors like mutual funds and ETFs. Unlike institutional clients, these retail investors are typically investing for their own retirement and prioritize traditional risk and return over murky ESG scores. 
ESG’s primary successes have been through institutional investments like retirements, pensions, and other exceptionally large shareholders, often bringing along people who are unaware that asset managers are considering factors other than risk and return when stewarding their money. Those friendly to ESG claim that this indicates market demand, relying not on any meaningful shift in the behavior of millions of American investors, but on some strongly worded statements from the likes of Michael Bloomberg and BlackRock. While it may be tempting to sympathize with the travails of the world’s largest asset manager, this ignores the fact that the revealed preference of individual investors is still to make money, rather than mix politics into their portfolio.
Indeed, all evidence suggests market forces are trending away from ESG. Pro-ESG investment industry association US SIF issued a report in late 2022 that puts the total of US “sustainable investment assets” at $8.4 trillion. This is just less than half the amount in US SIF’s last report, in part because of their own double-counting of ESG funds, yet this has been cited as an indication that demand is increasing. More importantly, Lipper reports that investors withdrew a net $13.2 billion from ESG funds of all categories through November last year. This is separate from the fact that ESG funds also underperformed in 2022. Through November, ESG equity funds lost 18% of their value — more than 2% worse than non-ESG peers — owing to the bear market in the ESG-friendly tech sector. This resulted in a 29% total decline in net assets in ESG mutual funds, compared to a 21% decline in non-ESG assets.
In terms of both investor behavior and fund performance, ESG investing is facing more headwinds than it has in a decade. And for all this talk about risk mitigation being the purpose of ESG, it appears proponents didn’t consider the risk of reducing overall diversification in favor of sectors with high ESG scores, which contributed to ESG funds’ underperformance. None of this is the fault of Republican lawmakers, but ESG itself. As marketing for ESG strategies continue to push the notion that investors are putting “their money where their values are,” it is becoming increasingly difficult to view the movement as a risk mitigation process that goes hand-in-hand with free-market capitalism. Instead, it belongs in the domain of Senators Whitehouse, Schatz, and Heinrich: politics.
Mike Viola is the head of analytics at the Foundation for Economic Education (FEE). He previously worked for five years in investment research. You can find him on Twitter @mf_viola.