Budget & Finance

ESG: The Hotly Contested Investment Strategy That Could Pose Trouble for Teacher Pensions

By Mark Lieberman — March 08, 2023 6 min read
Illustration: ESG Concept of Environmental, Social and Governance.  Sustainable Development. Alternative Energy.
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Pension funds, including those that serve retired teachers and other school employees, are under increasing pressure from lawmakers and regulators to make or withdraw investments based on principles like social justice and environmental preservation, not just on the potential for big returns.

This approach has become loosely defined as “ESG,” which stands for environmental, social, and governance. Widespread debates and legislative wrangling over what the practice is and how it works could put further strain on already shaky returns for pension funds, according to experts who study retirement systems for public employees.

State mandates or pressure from state officials to make investments with social goals in mind, or to scrap that approach altogether, can leave pension fund employees uncertain about exactly which investments are off limits and what the primary objective should be.

Pension fund employees now find themselves thinking, “‘We’re struggling to say afloat, and now here’s this other problem coming at us that we have to navigate as we’re just trying to hit our marks,’” said Leonard Gilroy, senior managing director of the Pension Integrity Project at the Reason Institute, a libertarian think tank. “We can’t just aim for the target. Now we’ve got to do it right.”

ESG investing has recently risen in prominence thanks to bills that draw attention to it in Republican-led states like Indiana, Texas, and Florida and aim to ban, restrict, or discourage the approach.

Here’s some background on what ESG means, why it’s difficult to evaluate, and what it could mean for retired school workers.

Is ESG a newfangled thing?

Not at all. Even under different names, it’s a practice that dates back at least to the 1970s, when policymakers and advocates pushed for divestment from companies that manufactured tobacco and liquor, and the 1980s, when a movement arose to box out companies invested in South Africa, where apartheid reigned.

The North Will Rise Again, a 1978 book by economists Jeremy Rifkin and Randy Barber, helped popularize the connection between pension investment and societal problems, arguing that a socially conscious approach to pension fund investment could help reverse the decline of America’s northern industrial centers.

More recent ESG-focused investment efforts have been prompted by major national and global developments. They’ve included pushes to divest from Russian assets when the war in Ukraine began; gun manufacturers after high-profile mass shootings; and oil and gas companies that contribute to climate change.

Distinct from the investment side, companies also adopt ESG principles around practices like diversity in hiring and partnerships with other like-minded companies. The Ohio Association of School Business Officials last year published a post on its website urging district administrators to consider adopting ESG policies to make their bond issues more attractive to investors.

Why has ESG investing grown more prominent recently?

Investors have grown interested in ESG approaches in recent years as a way to advance social causes through their financial decisions. The term attracted broader mainstream awareness in 2021 when a small ESG-focused investment firm muscled its way into electing three Exxon-Mobil board members who pledged to push the company toward clean energy.

Companies with ESG policies, or those that urge other companies to pursue similar policies, controlled more than $8 trillion in assets last year, according to the U.S. Forum for Sustainable and Responsive Investment.

The federal government is playing a role in the emergence of ESG as well. In 2021, the Securities and Exchange Commission established a task force dedicated to identifying ESG-related misconduct. And a 2022 regulation from the U.S. Department of Labor removed Trump-era restrictions on investment strategies that use ESG approaches. President Joe Biden recently pledged to issue the first veto of his presidency after both chambers of Congress voted to overturn that regulation.

Does ESG investing fall neatly along partisan lines?

Not exactly. Republican governors have derided ESG investing as “woke” investing run amok. Bills from conservative lawmakers under consideration in Florida, Indiana, Texas, and Utah would prohibit or restrict pension funds and other institutions from investing in companies that adopt an ESG framework.

Texas last year barred 10 companies and more than 300 investment funds from doing business with the state because they have corporate policies that limit fossil fuel investments. In Mississippi, State Treasurer David McRae late last year urged the state employees’ pension fund to avoid ESG investing and to divest from BlackRock, the investment management company that has made a high-profile show of considering sustainability in its investments.

But these efforts themselves could fall under the category of ESG investment—just with the goal of opposing social justice and environmental efforts and punishing companies that support them, said Josh McGee, who studies retirement policies in his role as associate director of the Office for Education Policy at the University of Arkansas.

How much ESG investing are pension funds doing?

It’s not easy to tell. Roughly three-quarters of 176 pension funds reviewed by researchers at the Center for Retirement Research at Boston College for a 2020 report had some sort of ESG policy or state mandate in place.

Some funds specifically adopt an ESG label, making them easy to track.

But other ESG investing isn’t necessarily labeled as such, or involves scaling back investments in companies with a particular stigma.

Investing with an ESG lens can be more time-consuming than traditional investing. As a result, ESG mandates often lead pension funds to outsource investment decisions to companies like ISS and Glass Lewis, said Gilroy. Those firms’ mandates from their pension fund clients may be somewhat vague, which means researchers might not always be able to easily interpret the companies’ decisions.

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Illustration of money being carried away by a balloon that says "pensions"
Cemile Bingol/DigitalVision/Getty; Liz Yap/Education Week<br/>

Why are pension experts concerned about ESG investing and the backlash to it?

Pension funds are already stressed. Investment returns took a nosedive at times during the pandemic. A recent report from the Equable Institute found that states’ and school districts’ pension obligation have soared. And long-term economic prospects remain uncertain.

With all that in mind, pension experts worry that efforts to divest from particular companies for social reasons could do more harm than good. The traditional fiduciary approach to investing prioritizes maximizing returns and virtually nothing else. By contrast, ESG investing narrows the pool of potential companies in which to invest.

Does ESG investing pose a risk to pension benefits for teachers?

Possibly. The Boston College report found that state mandates around ESG led to marginally lower pension returns.

They can also create administrative dilemmas for pension funds. For instance, Texas is moving to ban ESG investing, but it also has a law on the books that prohibits state retirement funds from investing in companies that do business in Iran—a policy in service of a political goal.

“Is it only things that are called ESG that are banned?” McGee said. “It’s just very slippery.”

ESG itself might not pose an existential threat to pension fund returns. But to McGee, the approach represents one of several factors straining pension systems.

“No individual mandate or restriction is that big,” McGee said. “But as you start to layer mandates on, they can get more sizable.”

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A version of this article appeared in the March 29, 2023 edition of Education Week as ESG: The Hotly Contested Investment Strategy That Could Pose Trouble for Teacher Pensions

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