Environmental, social and governance investment principles play a major role in many public pension funds run by states that haven’t joined the conservative-led backlash against so-called “woke investing.” Now a new study shows that pro-ESG funds in those typically blue states outperform those in Republican-controlled states.
Public pension funds in Democrat-led states, which tend to be open to, favor, or sometimes require the use of ESG criteria when selecting investments, returned an average 9.1% a year over more than a decade through 2022, according to a new report shared exclusively with ImpactAlpha by HIP Investor, an impact investment advisory firm in Laguna Beach, Calif.
By contrast, the average yearly return by public pension funds in Republican-led states over 2011–2022 was a lower 8.8%.
“The self proclaimed ‘party of business’ Republicans can’t seem to systematically achieve higher pension returns for state pensions,” HIP’s R. Paul Herman told ImpactAlpha. “The GOP sounds off regularly as a defender of free markets, yet pursues anti-ESG laws and proclamations that appear to correlate with lagging pension returns.”
The HIP study looked at investment performance data available on nonprofit Public Plans Data for 204 US pension funds consisting of 117 state, 15 county, 66 city and six city-county school plans. So-called “purple” states, with mixed party affiliations in their executive and legislative branches, had the lowest performance, an average 8.6% return.
The numbers are even more stark for states with anti-ESG laws: their 8.5% average return lagged the 9% average in states with pro-ESG laws.
The financial toll for millions of America’s teachers, firefighters, government employees and other public-sector pensioners is high. The cumulative loss for pension funds in red states with an “anti-ESG” stance, including those with laws that ban ESG criteria when investing or using taxpayer dollars: $159 billion over 12 years, the report said. Some $133 billion of that total comes from states with “anti-ESG” laws.
Herman said that the study, finalized in May, doesn’t address the performance of any particular investments in ESG-themed index or private equity funds. Those are typically part of a larger, risk-diversified mix of holdings. Instead, he said, the study underscores the core, data-driven finding that ESG can “generate stronger financial returns, and lower financial risk.”
Because the HIP study considers pension fund performance in years before some states, including Florida, Oklahoma and Texas, enacted anti-ESG laws for use of public monies, those funds likely have lower long-term returns due to their recently adopted stances, Herman says. The study doesn’t address wide variations in definitions of ESG.
ESG backlash
The new study shines a light on the cost to pensioners of the Republican stance against ESG. Other recent analyses have highlighted the financial toll on taxpayers and local economies in states such as Texas and Florida that have adopted laws banning public agencies from doing business with investment firms that consider ESG risk.
A separate report showed that after banning municipalities from hiring ESG-affiliated banks, Texas incurred up to half a billion dollars in additional interest on $31.8 billion borrowed due to decreased underwriting competition in the state. In March, Texas banned Blackrock from financial management of $8.5 billion in state assets, citing a Texas law that prohibits state investment in companies that “boycott” energy companies and Blackrock’s “dominant and persistent leadership in the ESG movement.”
The HIP study findings are averages. The Employees Retirement System of Texas (ERS) Retirement Trust Fund returned 9.3% over five years through the first quarter of 2024. While it’s not an apples-to-apples comparison, the HIP study said that annualized returns by states with anti-ESG laws have lagged those of 32 states without the laws by 0.5% a year.
As of last September, 20 states had “anti-ESG” laws on their books for public monies, according to law firm Morgan Lewis. The regulations include orders to divest from and refuse to contract with companies that boycott industries such as fossil fuels or firearms, and prohibitions against considering ESG-related goals when making state-sponsored investments.
Eight states, including Connecticut, Illinois and Maine, have pro-ESG rules that seek to protect or incentivize ESG-related investments. More than 75 anti- or pro-ESG bills are pending in current state legislative sessions in 41 states across the US, the law firm says.
While Republicans politicize ESG, most public pension funds see ESG-themed investments as a hedge against future risks posed by climate change, inequality and other environmental and social factors.
Many pension funds, including CalPERS, the country’s largest, and New York State Common Retirement Fund, aren’t retreating. CalPERS’ Peter Cashion told PitchBook last month that the fund’s $100 billion earmarked for climate investing reflects “the midst of a climate revolution.”
Pew Charitable Trusts writes that “There is widespread agreement among experts that environmental factors in particular will pose systemic risks to the broader financial system and, in turn, to the more than $5 trillion in assets invested by public pension funds.”
Freedom to invest
Last September, a federal judge in Texas appointed by former President Donald Trump upheld a Biden administration Labor Department rule allowing employer-sponsored retirement plans, mainly 401(k)s, to consider ESG factors as a “tiebreaker” factor when vetting financially similar investments. The Biden rule, which overturned a ban by Trump in 2020, now faces a challenge in an appeals court.
Some 25 Republican-led states and oil drilling company Liberty Energy sued to block the rule. The case is a test of what will happen after the US Supreme Court overturned the longstanding Chevron deference rule, which held that federal agencies are best equipped to interpret and make rules.
Public pensions are pushing back against a probe by the Republican-led House Judiciary Committee on a “climate cartel” of “left-wing activists” and major financial institutions that “collude to impose radical environmental, social, and governance (ESG) goals on American companies.” (See, “On hearings and being heard”).
More than one in three global pension funds have “overt ESG goals,” according to a study of 152 funds, a little more than half in the public sector, by Bermuda-based financial services provider Apex Group last October. Nearly three in four said they were aiming to maintain or increase their allocations to ESG-related funds within the next three years.
More recently, pension funds from New York and California, along with dozens of state treasurers, are mobilizing under the banner “Freedom to Invest” to present a unified message to policymakers: “Protect the freedom to invest responsibly.”
