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To skeptics, ESG is distracting fund managers from seeking better returns

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To skeptics, ESG is distracting fund managers from seeking better returns

Many on Wall Street have embraced sustainable investing, but not everyone in the investment community is convinced of its merits.

Environmental, social and governance, or ESG, strategies have captivated the world's largest asset manager, activist short sellers and a generation of young investors in recent years. But a cohort of critics is still doubtful that sustainability-focused investments will pay higher returns for end investors, despite the swelling base of market participants incorporating ESG into their strategies.

The lingering concerns over ESG made headlines in the asset management world when Jason Perez won his campaign to join California Public Employees' Retirement System's board on a platform that decried the massive pension fund's commitment to sustainability principles. Perez defeated the board's current president, Priya Mathur, who has helped steer CalPERS toward its ESG commitment during her 15-year tenure on the board.

"Announcing what [CalPERS] wants to change in the world is not right, and it should not be done with retirement money," said Perez, a Corona, Calif., police sergeant, in an interview. "If it's legal and not supporting terrorism, we should be involved" if the returns are strong enough, he said. Mathur did not respond to a request for comment.

CalPERS has been a leading force in responsible investing for several decades. The pension fund is working toward including sustainable investment strategies across all its $351 billion in assets, as the institution believes those practices can help minimize the fund's risks, extend its longevity and maximize returns in the long run with factors like climate change becoming more prominent.

Yet, Perez campaigned on the notion that CalPERS' approach to sustainable investments was a part of the reason why the institution, which oversees the retirement funds for approximately 1.9 million state employees, has struggled to make consistent returns. At the end of June, CalPERS' assets were worth about 71% of what the institution owes in retirement payouts to beneficiaries.

Perez will join a 13-person board that carries a fiduciary duty for the investments made by the CalPERS system. The board, which helps set the system's investment asset allocations, has exclusive control over CalPERS' funds. Throughout his campaign, Perez was supported by current CalPERS board member Margaret Brown, who also unseated a long-standing member of the board in a 2017 election.

Perez is not alone in thinking that the pension fund giant's sustainable investment philosophy is hobbling returns. In 2017, the American Council for Capital Formation, a Washington, D.C.-based think tank, published a report saying CalPERS was placing political beliefs over its legal obligation to stabilize the fund by focusing on maximizing returns.

"Be as engaged as you want, but if you're engaged and it shows a negative impact on the shareholders, then we're going to say what you're doing is not in their best interest," said Tim Doyle, vice president of policy and general counsel at the American Council for Capital Formation, in an interview.

The think tank collected 85% of its 2017 revenues from a range of corporations including Exxon Mobil Corp., Halliburton Co. and S&P Global Inc., the parent company of S&P Global Market Intelligence.

The uncertainty around ESG's impacts on returns has caused apprehension among some fund managers and portfolio managers. But that trend has started to turn in 2018.

An October survey from RBC Global Asset Management Inc. found that 89.6% of the 540 respondents believe ESG-integrated portfolios will perform at least as well as portfolios without any incorporation of ESG strategies, up from 82.4% in 2017. The adoption of such funds also saw sizable expansion in 2018 with 72.2% of the respondents using ESG principles to some degree, versus 66.6% in 2017.

An S&P Global Market Intelligence analysis in July found that ESG exchange-traded funds have outperformed the median ETF over one- and three-year periods by wide margins.

The concerns over returns likely hail from confusion in the marketplace, Judy Cotte, RBC Global Asset Management's head of corporate governance and responsible investment, said in an interview.

Cotte said critics may be conflating ESG investing with socially responsible investing, which she defined as an investor aligning their portfolio with personal values and beliefs.

That practice can lead to investors diluting their stakes in companies dealing with controversial topics like weapons and tobacco. CalPERS does not invest in primary tobacco companies or companies that manufacture assault-style weapons, which are illegal for sale in California, or make such firearms available to private individuals.

But CalPERS views its approach to sustainable investment as a way of considering how future shifts in the environment, workforce or society will impact its assets.

"We'll never be able to entirely future-proof our portfolio," Beth Richtman, CalPERS' managing investment director for sustainable investments, said in an interview. "But our goal is to try as much as possible to understand as fully as we can what risks and opportunities might act on our portfolio."