What Are Anti-ESG Funds, and Should Sustainable Investors Be Worried?

The political pushback against "woke capitalism" continues, extending from how brands engage with Pride Month to how they source their energy.

In the financial sector, anti-woke campaigners have set their sights on the use of environmental, social and governance (ESG) factors in investing. Fund managers say they use ESG criteria to manage risks tied to things like climate change and human rights. But the anti-woke set claim that ESG screens dampen investor returns and pressure companies to follow a particular "political agenda." 

We've read plenty about the burgeoning "anti-ESG" movement, led primarily by a small set of right-wing politicians and pundits. But have you heard of "anti-ESG" investment funds? Yes, such an animal exists, and a Morningstar analysis published last week offers a closer look.  

"This is the first time that Morningstar systematically looked into anti-ESG funds," Alyssa Stankiewicz, associate director of Morningstar's sustainability research division, said on a call with reporters last week. "It's always kind of fun to start research from the ground up that hasn't been done, and I think we learned a lot along the way." 

What are anti-ESG funds?

As with the "anti-ESG" term more broadly, the designation of anti-ESG funds can mean different things to different people. Morningstar breaks the funds down into five categories.

• Anti-ESG: These funds use ESG data to build their portfolios "by tilting toward companies that management believes are unduly penalized by ESG ratings providers," according to Morningstar's analysis. 
• Political: These funds grew out of the backlash against "woke capitalism." They decry ESG screens as part of the "liberal agenda" and tend to "invest in companies believed to be supportive of conservative-values-aligned policies," the report reads. 
• Renouncer: These funds "previously claimed to adhere to ESG investing principles but subsequently removed references to ESG principles from fund names and documents for fear of being associated with the ESG movement" amidst political backlash. 
• Vice: These funds "invest in companies traditionally excluded by socially responsible or ethical funds" (think: "sin stocks" in sectors like tobacco, weapons and gambling). 
• Voter: These funds are passive and track specific sectors or market indexes, with "voting policies in opposition to ESG principles."

"We took a pretty broad approach to searching for the funds that could be considered anti-ESG funds, and we wound up with 26 funds in the Morningstar Direct database, which we analyzed by their prospectus language, their marketing materials, and different portfolio characteristics," Stankiewicz said. 

Some of these funds — particularly "vice" funds made up of sin stocks — have been around since the early 2000s, but things "really took off in the third quarter of last year," Stankiewicz said. 

That's when biotech entrepreneur Vivek Ramaswamy founded Strive Asset Management with backing from investors like Peter Thiel. The company billed itself as an aspiring BlackRock competitor that wouldn't pressure the firms in its portfolio to “push political agendas," Ramaswamy said at an event in December, as quoted in the New Yorker. 

Strive made a big splash in the news given rising anti-ESG rhetoric, and its introductory fund — the Strive U.S. Energy ETF — was well received among investors, attracting "nearly $100 million in its first week and more than $300 million in its first month," according to Morningstar. 

While Ramaswamy referenced the anti-ESG push in his public remarks about the firm, Strive's "prospectus filings include no reference to ESG principles, for or against," Morningstar found. Instead it offers seven passive, exchange-traded funds (ETFs) that track markets like energy and semiconductors, as well as indexes tied to things like dividends and growth potential. "The key differentiating factor from other passive funds is their proxy-voting policies, which state that the firm will generally oppose environmentally or socially motivated shareholder proposals," the report reads. 

As such, Strive's funds make up all of Morningstar's "voter" category. Believe it or not, only one fund — Constrained Capital's ESG Orphans ETF — made it into the "anti-ESG" category, meaning it was founded with the expressed purpose of investing in companies that are supposedly disadvantaged by ESG screens. "Political" funds include the American Conservative Values ETF, launched in 2020 with messaging that called on investors to move their money away from supporting the "woke/liberal agenda."

"It is important to note that Morningstar does not view ESG investing as specific to any one political party, but the recent explosion in anti-ESG sentiment is driven primarily by a vocal subset of Republican politicians," Stankiewicz and fellow Morningstar analyst Mahi Roy wrote in the report. 

How are anti-ESG funds performing?

Their name may be on-trend with current rhetoric, but these funds aren't exactly catching on with investors. Flows into anti-ESG funds peaked at $376 million in the third quarter of last year, according to Morningstar's analysis. But 80 percent of that came from a single fund: Strive's U.S. Energy ETF.

"What started as a downpour slowed to a drizzle," Stankiewicz and Roy wrote in the report. Strive's six following fund launches received a muted reception, attracting roughly $5.5 million monthly since they launched. Interest in the other funds Morningstar studied has remained flat, and the sole fund in the "anti-ESG" category — Constrained Capital's ESG Orphans ETF — filed to liquidate at the end of this month due to lack of capital. 

Are anti-ESG funds really anti-ESG?

Despite the marketing on these funds, many aren't all that distant from ESG principles when it comes to how the companies in their portfolios do business, Morningstar's research revealed. "Half of the funds in our list did carry above-average ESG risk" compared to the Morningstar U.S. Market index, Roy said on the press call. But researchers were surprised to learn that many are also heavily linked to positive environmental and social impacts. 

"Some of these funds, as much as they are a part of controversial industries, they also do have exposure to, for example, climate action or basic needs," Roy explained. 

The American Conservative Values ETF, for example, has a Morningstar Sustainability Rating of 4 out of a possible 5, while the Strive 1,000 Dividend Growth ETF earns a 5 out of 5. 

"We also actually did a holdings comparison," Stankiewicz said. "There were some distinct holdings ... some of which were renewable energy companies that were in Strive's portfolio that weren't in BlackRock's portfolio. Strive doesn't purport to invest for or against ESG ratings according to their prospectus. It's mostly about voting. But it is still interesting to observe the differences in holdings." 

Further, "many portfolios in our list have high levels of alignment to climate action impact," the report reads. "For instance, 84 percent of Strive U.S. Semiconductor ETF’s SHOC portfolio is involved in climate action impact, a whopping 48-percentage-point overweighting relative to the benchmark, followed by Strive 1000 Growth ETF and Strive 500 ETF at 43 percent and 36 percent, respectively."

The bottom line

With only a few hundred million dollars invested on a quarterly basis between them — compared to over $6.6 trillion across all U.S. ETFs last year — anti-ESG funds shouldn't exactly leave sustainable investors shaking in their boots. And the connection to positive impacts also indicates they aren't doing much to dampen sustainability objectives. 

Meanwhile, funds with ESG screens are on the rise after slowing in 2022. The Morningstar Global Markets Sustainability Index rose by 10.2 percent in the first five months of the year, compared to a 9.5 percent return for the Morningstar Global Markets Large-Mid Cap Index, according to a May analysis.

Even so, Morningstar plans to keep an eye on anti-ESG funds and how they develop into the future, analysts said. 

Image credit: Sam Valadi/Flickr