There’s a new wrinkle in the growing controversies over the rise of investment funds that promise to address environmental, social or corporate governance concerns. Amid investigations into allegations of “greenwashing,” or false promises of environmental improvements, and opposition to ESG measures from conservative political leaders, individual investors are gaining new opportunities to direct their money to funds pitched as contrarian responses to the ESG trend.
At least nine new exchange-traded funds (ETFs) — some signaling their purpose with symbols such as DRLL — launched last year in reaction either to ESG issues specifically or to what some of the new fund founders label as a liberal political agenda behind ESG. In their short history, the 2022 crop of funds has cumulatively gathered more than half a billion dollars in investments, though that is dwarfed by the more than $101 billion in assets currently invested in 279 U.S. ESG ETFs. In 2022 alone, investors put over $5 billion more into ESG ETFs than they took out, according to independent research firm CFRA.
An evolving debate on risk and shareholder value
Aniket Ullal, head of ETF data and analytics at CFRA, expects more political debates within the investment world. “Political intervention in ETFs is going to be an important story this year,” he says. Some state financial officials are already threatening to pull money from managers they charge are improperly using investments to further political agendas, and Republican leaders in the House of Representatives are threatening to investigate ESG investing.
At the root of the debate is whether shareholders are helped or hurt by companies’ efforts to report on or address issues such as climate change or socioeconomic inequalities. And should companies stick with a conventionally short time horizon to define a risk as “material” enough to warn investors about, or should longer-term risks merit inclusion in a company’s investor reports? Federal financial regulators have been challenged by the task of determining exactly what ESG risks are material to shareholders. We won’t debate that here. But now, a backlash has begun.
Over the long term, the financial record of ESG investing and its progenitor, socially conscious investing, is mixed. Such values-based strategies have been around since Methodist and Quaker settlers refused to invest in businesses they saw as sinful. In the early 2000s, ESG investing largely pivoted away from its socially responsible roots, which put impact first. ESG investors instead sought to maximize shareholder value by anticipating sustainability challenges like water scarcity.
Backlash funds reflecting opposing views have a long history as well. In reaction to the “socially responsible investing“ boom of the 1990s, for example, some mutual fund companies developed so-called “vice funds“ that focused on firms profiting from tobacco, alcohol, gambling or firearms. But there is no clear evidence that either strategy consistently outperformed the broader market.
A few of the funds that started in reaction to the current ESG trend have delivered market-beating returns recently. Still, most of the funds are too small or too new to warrant an investment recommendation, one way or the other, yet. And some funds are struggling to gather enough assets to cover their management and marketing costs. Just as investors must do when weighing pro-ESG investments, those who are intrigued by choices promoted as alternatives must wade through a variety of options.
Returns and other data are through January 31, 2023.
A new crop of ETFs opposed to sustainable investing
By far, the most successful of the counter-ESG funds, in terms of attracting assets, are from Strive Asset Management. Strive was founded last year by Anson Frericks and Vivek Ramaswamy, author of Woke, Inc. The firm launched seven index funds in 2022.
Strive’s strategy is to promise investors market-like returns through index funds — thus avoiding the danger of significant underperformance — while using its share ownership to vote proxies and engage with executives and board members to focus on, as Strive’s literature proclaims, “excellence over politics.” (Update: after this article went to press chairman and co-founder Ramaswamy announced he is running for U.S. President.)
Strive’s argument is that an ESG investing framework often detracts from profits. An analysis by the firm found more than 30 risk factors that investors might consider before buying a stock, says Matt Cole, Strive’s chief investment officer. He calls ESG-related risks “important,” but adds, “Where should those rank among the 30 to 40 risk factors? Probably, in our view, closer to the bottom.”
Strive is already engaging with corporate management directly. For example, following the 2021 addition of new members of the board of directors at Exxon Mobil (XOM) with experience in climate science and clean energy, Strive wrote to and met with executives to argue that the board was now too focused on climate change. It is unclear how much influence Strive had over the company, but Exxon Mobil did add two members to the board last December with more conventional business expertise.
Strive plans to engage with Dow stocks Chevron (CVX) and Home Depot (HD) in 2023, filing resolutions if need be, to counter recent successful ESG campaigns. In 2021, 61% of Chevron shareholders supported a proposal asking for greater climate disclosure. And in 2022, almost 63% of Home Depot shareholders supported a resolution seeking a racial equity audit to assess, among other things, the treatment of minority customers and the effectiveness of the firm’s diversity, equity and inclusion programs.
In addition to filing its own shareholder resolutions, Strive in January launched a new, alternative proxy voting advisory service, aimed at “advancing long-run value, not progressive social and political agendas,” according to Justin Danhof, Strive’s head of corporate governance.
Strive has quickly attracted more assets than the rest of the ESG alternative funds combined. The Strive U.S. Energy ETF (DRLL) has gathered roughly $400 million in assets since its August 2022 inception. The passively managed fund tracks a U.S. energy industry index, produced by index provider Solactive, which includes a wide array of energy subsectors but is most heavily weighted to oil and natural gas. The ETF’s top holdings are Exxon Mobil, Chevron and Conoco Phillips (COP). For context, Strive’s energy fund portfolio contains all of the 23 stocks found in the more established Energy Select Sector SPDR Fund (XLE), as well as about 30 additional companies, such as utility stock Exelon (EXC) and gas driller Ovintiv (OVV).
Strive’s large-cap index fund has garnered more than $113 million in assets since its August 2022 launch. Another sector fund, Strive U.S. Semiconductor ETF (SHOC), has collected more than $17 million in assets.
At least six other funds are focusing on using their assets — investor dollars — to either shun companies they believe are too liberal or to bet on firms they believe are being improperly boycotted by ESG-focused investors. Although many of these fund managers plan to vote their proxies, most say they are primarily focused on shaping portfolios that fit their values: “We believe disinvestment is more effective than engagement,” explains Bill Flaig, cofounder of the American Conservative Values Fund (ACVF), with about $36 million in assets. “The success that ESG investing had in raising assets did validate to us that people will invest with their values,” he says.
Flaig starts with the universe of firms with a market value of at least $4 billion, then screens out companies “perceived as hostile to conservative values.” But because Flaig tries to keep his fund’s sector allocations close to that of the S&P 500, he often ends up investing in companies that look similar to the boycotted ones. Mastercard (MA), which has firearms purchase coding practices, is one of the fund’s largest holdings, for example. “The reality is we need to have some exposure to that industry. A lot of times it does wind up being a lesser of two evils,” he says. The fund generally holds between 200 and 400 names. Only four of its top-10 holdings match those of the S&P 500: Microsoft (MSFT), Berkshire Hathaway (BRK.B), Nvidia (NVDA) and Exxon Mobil. In the year ending Jan. 31, the fund, which has an expense ratio of 0.75%, lost 5.9% — finishing well ahead of the S&P 500, which lost 8.2%.
In late 2022, a South Carolina–based financial adviser and radio personality launched a similar politically conservative (and anti-ESG) investing option, the God Bless America ETF (YALL). With more than $30 million in assets, founder Adam Curran starts with the universe of companies with market values of at least $1 billion, screens out companies he believes are espousing liberal politics, and then tries to make sure he provides exposure to all 11 main sectors in the S&P 500.
Besides nixing conservative targets such as Walt Disney (DIS) and Google-owner Alphabet (GOOGL), he says he also avoids the 118 companies whose executives signed the Business Roundtable’s Stakeholder Capitalism commitment, which calls on companies to shift from focusing solely on shareholder returns to also consider concerns of customers, employees, suppliers and communities.
“We certainly don’t like ESG. And we are the first ETF with the word 'woke' in the prospectus,” Curran says. But he says ESG ratings don’t play into his decisions. Curran’s largest holding is Tesla (TSLA), followed by Nvidia. Curran has been buying those stocks at what he believes are bargain prices since launching the fund in October. Their recent rebound is one reason the fund’s three-month return is 8.9%, compared with 5% for the S&P 500.
One new ETF specifically focused on anti-ESG investing is 2022’s Constrained Capital ESG Orphans ETF (ORFN). But their stance isn’t political. The name and symbol come from the idea stated in the prospectus that certain kinds of businesses are “‘orphaned,’ discarded or excluded by ESG-centric mutual funds,” and thus can be bought at lower prices. Top holdings: Exxon Mobil, tobacco firm Philip Morris International (PM) and defense contractor Raytheon Technologies (RTX).
Overall, the fund’s holdings were recently priced at an average multiple of just 14.7 times estimated earnings — below the 17.4 average for similar funds, according to the research firm Morningstar. The fund has lagged the broader market in the past three months, up 3.9%, compared with 5% for the S&P 500 index. With just $3.6 million in assets, the fund charges 0.75% in expenses. These funds are a sample of what is sure to be a wave of new market entrants in reaction to the ESG tsunami. Time will tell if these alternative offerings can garner the assets and deliver the returns they need to in order to thrive over the long haul.
