Small: ESG lawsuit highlights major issues

ESG lawsuit highlights major issues

By Jonathan Small

In 2022, Oklahoma lawmakers passed the “Energy Discrimination Elimination Act” (EDEA), which requires the state treasurer to identify firms that embrace “Environmental Social Governance” (ESG) policies. Those pro-ESG firms are barred from receiving state contracts, including management of state pension funds.

Opponents of the law have pushed back and obtained an injunction preventing its enforcement.

But an unrelated class-action lawsuit targeting American Airlines’ use of pro-ESG firms to manage its employees’ pensions shows some retired workers agree with Oklahoma lawmakers.

The complaint filed by pilot Bryan P. Spence accuses American Airlines officials of  breaching their fiduciary duties by allowing ESG investment of pension funds, saying that “jeopardizes the retirement security of hundreds of thousands of American Airlines employees.”

Spence’s complaint noted a sizable body of research shows ESG funds produce lower returns.

“ESG funds have an established record of underperformance,” the complaint stated. “In a recent paper published in the Journal of Finance, University of Chicago researchers analyzed Morningstar ESG ratings of more than 20,000 mutual funds representing over $8 trillion of investor savings. Although the highest ESG-rated funds attracted more capital than the lowest rated funds, none of the high ESG-rated funds outperformed any of the lowest rated funds.”

That underperformance has significant negative impact on the financial security of retirees.

“Over the past five years, global ESG funds have underperformed the broader market by more than 250 basis points per year, an average 6.3% return compared with a 8.9% return,” the complaint stated. “This means an investor who puts $10,000 into an average global ESG fund in 2017 would have about $13,500 today, compared with $15,250 he would have earned if he had invested in the broader market.”

The poor returns generated by ESG investing are a feature, not a bug, of the ESG system, the complaint noted.

“Depressed returns for ESG investing are predictable, given that the measures being pressed by left-leaning groups interfere with merit and performance standards, while contributing to lost opportunities,” the complaint stated.

The complaint noted that a meta-review of more than 2,000 studies found ESG-focused investing depressed returns. As trends go in research, that’s about as consistent as you can get.

I previously served as a member of the Board of Trustees for the Oklahoma State Teachers’ Retirement System, so I know firsthand that consistently outperforming market returns is key to keeping the promises made to pensioners and taxpayers.

If you want to use your own money to make political statements, and are willing to take losses in the process, that’s fine. But when you’re using other people’s money and putting other individuals at risk of a far less financially secure retirement, that’s something else entirely.

Oklahoma lawmakers were right to draw that line in the sand. The future financial security of thousands of state retirees depends upon Oklahoma prevailing in this legal fight.

Jonathan Small serves as president of the Oklahoma Council of Public Affairs.