As February turns to March, the finance world is waiting with bated breath for one of its most dubious annual traditions: The Larry Fink Annual Letter to CEOs. Since 2012, when the BlackRock chief executive wrote his first letter, the occasion has come to symbolise the growing threat both to shareholder capitalism and American democracy posed by investment houses’ crusade to force the principles of ESG, or “environmental, social, and governance” investing, down the throats of companies, investors, and the public.
ESG first entered the investment and banking mainstream as a survival strategy. In 2009, BlackRock had acquired Barclay’s Global Investors Ltd, making it the largest investment firm in the world with almost $3 trillion in assets under management (AUM), a sum larger than the total revenue of the US federal treasury. Politically speaking, BlackRock’s emergence as an investment superpower could hardly have come at a worse time. Amid the wreckage of the 2008 Financial Crisis and then the ululations of the “Occupy Wall Street” movement, public suspicion of big banks and corporations was at an all-time high. Finance, in particular, became a morality play: financial institutions were the greedy villains, while policymakers played the heroic civic advocates reining them in. For BlackRock, the chances of continuing to grow freely in such a hostile policy climate seemed remote.
But BlackRock’s leaders had an epiphany — one that would repeat itself in the C-suites of several of its competitors in the early 2010s. What if big investment houses could rebrand themselves as so unimpeachably virtuous and civic-minded that their virtue outshone even their regulators themselves? Such a strategy would be game-changing. Not only would it afford investment houses a mile-wide road to limitless growth; it could even, if played judiciously, accord the companies themselves quasi-governmental power.
The ESG principles underpinning that strategy had already been written. The 2004 United Nations report “Who Cares Wins,” which introduced the principles of ESG to a worldwide audience, suggested that investors would make higher long-term profits if they put more emphasis on environmental and social progress. The small print was that the task of defining these impossibly broad categories (“environmental” or “social”) would be left to international institutions. Per those institutions’ priorities, “environmental” would mostly focus on implementing CO2-reduction goals, while “social” would mean anything related to the UN’s stated social goals on issues such as gender parity, racial justice, and poverty reduction. In other words, from the very beginning, the goal of ESG was to harmonise the priorities of political elites with those of business leaders. This approach was nothing new in Europe, where Klaus Schwab and his World Economic Forum (WEF) had long blurred the lines between business and government. But in the US, where the WEF ethos had failed to take root and the shareholder remained king, it was a radical departure.
When the UN invited global financial institutions to sign onto the Principles for Responsible Investment (PRI) in 2007, the total global assets managed by ESG-minded investing vehicles was around $10 trillion. By 2020, a mere 13 years later, that has grown to more than $30 trillion worldwide and more than $17 trillion in the US. New private equity firms and investment outfits devoted purely to ESG — such as Al Gore’s Generation Investment — were springing up every year, and most large US investment firms began offering ESG-mandated mutual funds, leading Bloomberg in 2021 to project $53 trillion invested in ESG by 2025.
As the ESG agenda took hold, the individual investor increasingly found himself shunted aside. Admittedly, the roots of this shift lay in the early Eighties, when federal proxy voting rules were changed to allow fund managers such as BlackRock to vote on behalf of their clients. The idea was a good one at the time, in that it recognised that few individual investors have the time to attend shareholder meetings or the wherewithal to make their views known to company leadership. But it handed vast power to investment companies — admittedly under the understanding that they would vote on behalf of their clients for one purpose only: the maximisation of profits and shareholder returns. It was, however, only a matter of time before this power was exploited.
That time came in the 2010s, as investment companies began instead to vote in line with the ESG agenda. Company leaders who opposed this were either quickly made to see its inherent wisdom, overruled, or out of a job.
In 2020, BlackRock voted at 16,200 shareholder meetings on 153,000 company proposals. Frequently, these votes were against company management. According to the company’s own Investment Stewardship Annual Report: “In 2020, we identified 244 companies that were making insufficient progress integrating climate risk into their business models or disclosures. Of these companies, we took voting action against 53, or 22%. We have put the remaining 191 companies ‘on watch’. Those that do not make significant progress risk voting action against management in 2021.”
In the same report, BlackRock boasted of having voted against management more than 1,500 times for “insufficient diversity” in company management. This interventionist approach was hardly limited to BlackRock. At State Street Global Advisors, in 2017 alone, proxies voted against the re-election of board members at 400 companies that it felt had made insufficient effort to appoint female board members.
But for huge investors such as BlackRock, attending shareholder meetings remained a rather inefficient method of coercing company managers into accepting the Good News of ESG. By 2012, Larry Fink had already discovered a far better method: the royal proclamation.
Fink’s first few letters contained tell-tale signs of the revolution to come, particularly in 2015, when he chastised managers for returning too much money to their investors in dividends and buybacks. Then, in his 2018 letter, he went a step further, advocating that CEOs step away from traditional shareholder capitalism and toward ESG by embracing the idea of “stakeholders”. In his words: “Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate.” “Every company,” he wrote, “must not only deliver financial performance, but also show how it makes a positive contribution to society.” Allow me to translate: On behalf of millions of shareholders I’ve never met, I declare that they no longer truly own the companies they have invested in. Society does.
As Vivek Ramaswamy convincingly argues in his book Woke, Inc., this feint of widening the pool of “stakeholders” beyond shareholders marginalises the shareholder and elevates the manager. By making companies answerable to everyone, proponents of stakeholder capitalism make them answerable to no one.
In his 2020 letter, modestly subtitled “A Fundamental Reshaping of Finance”, Fink decreed that all American companies must redesign their businesses to align with the goals of the 2015 Paris Agreement on climate change, with the implied threat of shareholder activism or even divestment if they failed to do so. To that end, he declared that all portfolio companies would thenceforward need to define climate risk as investment risk in their financial analyses — a measure designed to disadvantage companies engaged in heavy industry or fossil fuel production or use, and likely shunt them into cleaner businesses. Furthermore, since the nearest-term climate risks for many businesses are government climate regulations rather than the actual effects of climate change, this is a thinly-disguised method for coercing companies into complying with international climate agreements.
Second, Fink stipulated that companies must disclose their climate risk to investors using accounting methods created by two organisations which are constituted primarily of representatives from investment companies including BlackRock and international organisations such as the UN, World Bank, and IFC. Fink ordered that these disclosures specifically draw a path to the two-degree global temperature increase stipulated by the Paris Agreement.
A reader sympathetic to Fink’s goals might reasonably ask why such use of the bully pulpit is a problem. After all, if companies don’t do the right thing on their own, why shouldn’t Larry Fink incentivise them to do so? But in making his demands, Fink is speaking with the authority of an elected representative who has polled his investors and found that his proposals have their universal support, when he has not.
Considering that BlackRock is headquartered in the United States, which within the last decade elected a president who withdrew America from the Paris Agreement, there are probably many BlackRock investors who would either reject ESG principles out of hand or else disagree with Fink’s methods of applying them. For example, while many Americans would agree with Fink that climate change is cause for concern, some would dispute the idea that reaching Net Zero emissions by 2050 is a workable strategy, or even that businesses should focus on climate change at the expense of prioritising other problems such as hunger, poverty or terrorism. Similarly, some individual investors might disagree with State Street’s insistence on gender and diversity quotas for company boards.
Living as we do in a free-market capitalist democracy, there is supposed to be room for disagreement on questions such as these. When companies disagree with one another, the result is that they choose different strategies, allowing the market to choose the best strategy in the long term. But when the CEOs of every company in America answer to Larry Fink first and their actual investors second, that diversity — and therefore, the probability that we ever discover the best strategies — plummets.
There is a further irony in this. Over the past decade, as investment houses such as BlackRock have exerted ever-greater influence over decision-making at their portfolio companies, investors have in fact been signalling for them to take a step back. We can see this in the growing popularity of passive strategies (in which investment companies take a backseat role) compared with active strategies (in which they more frequently buy and sell stocks and actively intervene in the affairs of portfolio companies to improve performance). In 2011, 21% of US AUM were managed passively, compared with 79% managed actively; by 2018, the split had narrowed to 36% to 64%. Parity is projected for 2025. BlackRock’s own active-to-passive balance has followed a similar trajectory. Their portfolio had been primarily actively managed until 2009. But by 2018, $3.9 trillion of their $6 trillion assets were invested passively. Just as BlackRock’s customers were voting with their dollars for the firm to intervene less in company policy, BlackRock’s leaders were declaring it their sacred duty to intervene more.
Over the years, ESG advocates have parried charges of overreach by responding that investing with ESG criteria is just as lucrative as traditional investing. This has always been a dubious argument: after all, if favouring ESG-friendly companies were a prudent financial strategy, an investor would not need to publicly commit to ESG in order to do it; it would simply be the best financial decision.
The evidence of ESG’s performance has until recently been ambiguous enough to offer ammunition to both sides. But that has begun to change. In 2022, eight of the top ten actively managed US ESG funds (including one of BlackRock’s) performed worse than the S&P 500. This demonstrates two things. First, that ESG funds are not some financial miracle. And second, that the performance of ESG funds is tightly bound to the tech industry, which had a terrible year in 2022. (Unsurprisingly, tech stocks are overrepresented in ESG funds, since it is easier for tech companies to claim low environmental impact than companies that actually make things.)
Not only is ESG failing to make money, but it is not even achieving its non-financial goals. One sizeable Columbia University and London School of Economics study published in 2021 found that US companies in 147 ESG portfolios had worse compliance records for both labour and environmental rules than US companies in 2,428 non-ESG portfolios. They also found that companies added to ESG portfolios did not subsequently improve compliance with labour or environmental regulations. This study added to a growing body of evidence that ESG investing is not only anti-democratic but ineffective.
Over the past few months, investment companies have begun to take notice. Of particular note was investing giant Vanguard’s December 2022 decision to pull out of a Net Zero 2050 pledge. Last week, Vanguard CEO Tim Buckley told the Financial Times: “We don’t believe that we should dictate company strategy […] It would be hubris to presume that we know the right strategy for the thousands of companies that Vanguard invests with.” The just-announced presidential campaign of Vivek Ramaswamy, one of the most articulate spokesmen on ESG’s excesses, will doubtless only amplify demands for corporate independence.
Larry Fink has not yet posted a 2023 letter. Perhaps he is delaying as he contemplates how to respond to the growing anti-ESG tide, a tide he bitterly decried at the January WEF in Davos. I might be unusual among ESG detractors in my belief that Fink should write another CEO letter this year. But it should be a very short one, the writing of which is unlikely to take too much time away from his busy schedule of saving the planet through regular flights to Aspen and Davos. The letter should read, simply: