ESG has a branding problem. Here's how pension funds, money managers are adapting.

ESG in the midst of a makeover.

In some U.S. states, the three letters standing for environmental, social and governance have become toxic, even though institutional investors and pension fund executives continue to incorporate ESG into their investment process, believing that managing risk on matters such as climate change and associated floodwaters, for example, is essential to protecting their investments.

In Europe, ESG doesn't appear to be as politicized, but it has become a red state-blue state flashpoint in many parts of America.

Some states in the U.S., including Florida, Missouri, North Carolina, Oklahoma and Texas, have barred consideration of ESG factors

A new law in Oklahoma, for example, requires public pension funds to sever ties with firms said to discriminate against the oil and gas industry. Enforcement of that law recently was blocked with a temporary injunction by a judge, part of a lawsuit by a pension beneficiary. During the pause the $11.6 billion Oklahoma Public Employees Retirement System renewed a $7.3 billion contract with BlackRock, a money manager blacklisted by the state's Republican Treasurer Todd Ross for allegedly boycotting the fossil fuel industry.

Florida Gov. Ron DeSantis is leading a group of 19 Republican state governors, which was formed to "protect individuals from the ESG movement that threatens the vitality of the American economy and Americans' economic freedom."

Nationally, there is a bill to ban defined contribution plans from considering ESG factors introduced by Rep. Greg Murphy, R-N.C. in March.

Some pension funds and other asset owners have stopped using the term ESG altogether.

CalPERS is no longer using the initials ESG, replacing it with sustainable investment, said Dan Bienvenue, the $485.8 billion pension fund’s interim chief investment officer at the Milken Institute Global Conference in Los Angeles in May.

Officials at the California Public Employees’ Retirement System, Sacramento, took that step because the term has become so toxic, Bienvenue said.

"I think, unfortunately, ESG has become polarized," Bienvenue said.

But another California pension fund still uses the term ESG.

“ESG is just one of many ways to refer to long-term business risk,” said Mindy Tirapelle, a spokeswoman at the $336.2 billion California State Teachers' Retirement System, West Sacramento.

“We do still use ESG when appropriate and expect our team and external managers to adhere to our Investment Policy for Mitigating ESG Risks,” she said.

As a global investor with a long-term horizon, CalSTRS officials are “focused on sustainable business practices that lead to global economic growth and prosperity” as well as investment risks, Tirapelle said.

The $54 billion New Mexico State Investment Council, Santa Fe, could soon review its diversity, equity and inclusion policy.

Catherine Allen, chair of the council’s governance committee has said she plans to ask her committee and the investment council staff to develop a draft diversity, equity and inclusion policy as part of its work. Any proposal or policy would then go to the full council for additional consideration and possible implementation, a council spokesman said.

“In broad terms, the NM State Investment Council views ESG characteristics as important factors as we assess new investment opportunities, as well as being a key consideration when evaluating our current managers and their performance,” the spokesman said.

Money managers are still leaning toward keeping the ESG brand. According to Pensions & Investments’ latest data, most managers said they still use ESG or environmental, social and governance terminology.

The next most popular term was sustainability, while some managers used both ESG and sustainability.

Some industry insiders say that ESG is in need of a new label.

“ESG certainly needs to be rebranded; What the name insinuates is that it relates to businesses who care more about E, S, and G than they do profits,” said Will McDonough, founder and chairman of Corestone Capital, a merchant bank that has worked with private equity firms. “At the end of the day investors want profits and gains, and have a separate pocket for charitable endeavors.”

McDonough said that ESG also needs a common definition — or it needs to be abandoned.

“The problem is, ESG has no central office or governing body, or marketing budget centralizing a branding effort and/or standards to adhere to, so therefore, it will never gather enough critical mass to be rebranded,” he said.

McDonough added, “ESG should just be called charitable donations, and leave the investment opportunities to those that seek profits and returns, and if you want to back social initiatives, donate to a charity that is in that ‘business.’”

There are efforts underway to create common language for ESG factors. Last year, the International Sustainability Standards Board released global sustainability and climate disclosure standards for companies. The standards are designed to communicate sustainability and climate-related risks and opportunities to investors.

Greg MacKinnon, director of research at Pension Real Estate Association, a real estate trade association, agrees that ESG has a branding problem.

“What people call the ESG backlash is real,” MacKinnon said. “It’s unfortunate that real estate has been caught up in it along with other asset classes.”

PREA gives out ESG awards and officials at the industry group, which is made up of asset owners, portfolio managers and others, considered changing the name, “but what do you change it to?” he said.

“What if sustainability becomes the next bad word? Sustainability, responsible investing. It all kind of means the same thing,” MacKinnon said. “It’s really a branding issue.”

PREA executives decided to stick with ESG for now and see how things develop over time, he said.

In real estate, the anti-ESG arguments don’t hold water, he said. The evidence is clear: good environmental performance is good for investment performance, a 2022 PREA study showed.

Resistance to the ESG moniker varies from investor to investor, manager to manager, he said.

Rather than calling it ESG, PREA members talk about making sure they have resilient investments and that they mitigate risks and preserve property value over time, MacKinnon said.

“A number of people haven’t changed what they do, they changed how they talk about it,” he said.

The branding problem puts money managers in an odd spot, MacKinnon said. They may go visit an investor who grills the manager on ESG while yet another investor doesn’t want to see the acronym ESG in the manager’s presentation, he said.

But even in jurisdictions that are thought of being anti-ESG in nature, some investors will be interested in appropriately designed strategies that will, for example, take measure of the environmental characteristics of properties. These investors consider taking these characteristics into consideration as good investing practices rather than ESG, MacKinnon said.

“They don’t call it ESG necessarily but emphasize those characteristics as the ones that will lead to better investment performance,” he said.

Among Institutional Limited Partners Association members, some are calling ESG by another name, while others are not, said Matt Schey, managing director for external affairs and sustainable investing at ILPA.

“The organizations (both LP and GP) who have pivoted away from using ‘ESG’ typically trend toward something a bit more specific and defined, in some cases, breaking the acronym apart,” Schey said.

Some are avoiding the term in an attempt to depoliticize the conversation around it, which has become a distraction from the actual work being done, he said.

And location matters. Of the LPs headquartered in Europe, 70% agreed or strongly agreed that ESG commitments influence valuation premiums, according to a 2022 ILPA survey. However, only 38% of LPs headquartered in the U.S. held the same opinions, the survey revealed.

What’s more, nearly three-quarters of North American respondents cited the potential for negative publicity as a reason to scrap an investment, while half of European LPs shared this concern.

At the same time, 78% of European LPs considered a firm’s lack of desire to improve on poor ESG performance a deal-breaker, compared to only 44% of North American LPs, the ILPA survey showed.

“In my view, the work being done is more important than the label or acronym we choose to describe it,” Schey said.

Fundamentally, this is a way for investors to consider material risks through the lens of environmental, social and governance considerations, he said.

“You can call it whatever you want — the true value is how effectively you can connect the processes you have, or say you have, in place to creating value for your clients and beneficiaries,” Schey said.