The Unintended Consequences Of ESG Activism
As of the end of 2019, Blackrock (the largest asset manager in the world) held $7.4 trillion in assets. To put this in perspective, relative to the $90 trillion value of the global stock markets, Blackrock’s holdings equaled 8 percent of the total value.
Given its size, it was inevitable that proponents of Environmental, Social, and Governance (ESG) investing would target Blackrock. And, from Al Gore to Mercy Investment Services, ESG advocates have relentlessly criticized Blackrock.
Much of this pressure has focused on the problem of global climate change. Mercy Investment Services (Mercy), for instance, holds Blackrock accountable for “failing to use its multi-trillion-dollar might to encourage companies to divest from harmful fossil fuels”. Not being satisfied with controlling which assets Blackrock should hold, Mercy also wants to control Blackrock’s votes at annual meetings.
Taking the position that every climate-related resolution presented at a corporate annual meeting must be, by definition, appropriate and worthy, Mercy was disappointed that Blackrock only supported six (out of 52) of these resolutions. Mercy declared that this voting record was “inconsistent” with the asset manager’s climate change rhetoric.
Following these criticisms, Blackrock has announced that “it will avoid investments in companies that have a high sustainability-related risk, a move the firm’s CEO Larry Fink says will fundamentally change how American companies conduct business.” Blackrock is operationalizing these changes by exiting its investments in coal production, and introducing funds that ban fossil-fuel stocks. Blackrock also plans on voting “against corporate managers who aren’t making progress on fighting climate change.”
Referring to this change as “progress” Mercy Investment Services noted that “dialogue with BlackRock” led Mercy to withdraw its resolution and the pressure campaign it had been conducting against it.
Blackrock’s new investment policy does not necessarily mean these funds that refuse to hold fossil fuel investments will perform poorly. Clearly it is possible to create a profitable investment portfolio that excludes fossil fuel companies. After all, “the performance of six stocks [Facebook, Amazon, Apple, Netflix, Google, and Microsoft FAANGM] drives nearly one-quarter of the movement in the [S&P 500] index.”
If Blackrock believes that alternative energy technologies are a sound investment, Blackrock should allocate more of its actively managed funds toward such investments. The company should also be offering its investors the option of investing in ESG funds if there is a strong demand for these investment vehicles.
Nevertheless, Blackrock’s position warrants caution because there is no effective way for the company to operationalize the ESG commitments that it has declared without hurting its own investors. There will also be unintended consequences that will impose large costs on the U.S. economy.
Investors in Blackrock’s actively managed and ESG funds are not the company’s only clients – in fact, more than half of the money that Blackrock took in during 2019 was invested in passive funds. These passive funds will hold some variant of the total market.
This means that, by definition, Blackrock will continue to invest in fossil fuel companies on behalf of its passive fund investors even as its ESG position is actively discouraging these investments and attempting to put downward pressure on the stock prices of fossil fuel companies. The same caveat applies to companies that do not adhere to Blackrock’s newly defined ESG policies. To the extent that Blackrock’s new ESG policies are successful, the returns of investors in broad-based index funds will be harmed.
Should oil demand fall off as the ESG investors envision, perhaps these stock price reductions would have happened anyway. But, the projection that the future demand for oil will decline is far from certain, and there are many reasons to believe that the peak oil demand projections are purely speculative.
Besides fueling one-third of the world’s energy needs, oil is an irreplaceable component of thousands of products that consumers use every day (all plastic products, for instance). Electric vehicle sales, which are supposed to be a major displacer of oil demand, still represent only 2% of global vehicle sales. This is why the International Energy Agency’s (IEA) declining oil demand scenario is just one of several possibilities. In the other scenarios, the IEA forecasts that global demand for oil will continue to grow for the next two decades.
While currently volatile, fossil fuel production will remain economically necessary and financially profitable should oil demand remain strong over the next two decades. Under this scenario, Blackrock’s ESG activities (due to its size) would have an unjustifiably negative influence on the stock price of fossil fuel companies harming its own investors in passive funds.
Many of these investors are public and private pension funds. Lower returns create a material risk for pensioners in the future. For private sector pensioners, the result could be a less secure retirement. Public sector pensioners will either face a less secure retirement or the state will offload these losses to taxpayers by raising taxes or cutting public services in the future.
Then there are the risks created when corporate managers are strongly encouraged to adhere to Larry Fink’s definition of “climate change progress”. Pressuring all company managers to parrot the one-size fits all Blackrock position on climate issues increases the risk that ineffective climate solutions will be adopted.
Ultimately, the trillions-of-dollars that Blackrock invests do not belong to the company’s managers. These resources belong to the investors who have entrusted their savings to them. It is simply inappropriate for Blackrock managers, let alone unconnected ESG activists, to use this multi-trillion-dollar portfolio as a slush fund to enact their desired political agendas.
Making this bad situation worse, these ESG actions jeopardize the returns for some clients violating the very reason investors have put their trust in Blackrock. Faithfully executing on its investment service for all clients is the most important social responsibility Blackrock can perform.
I am a Senior Fellow in Business and Economics at the Pacific Research Institute and the Director of PRI’s Center for Medical Economics and Innovation. My research explores the connection between macroeconomic policies and economic outcomes, with a focus on the health care and energy industries. I have over 25 years of experience advising Fortune 500 companies, medium and small businesses, and trade associations. I received my Ph.D. in economics from George Mason University.