G in the ESG is Governance = Fiduciary Accountability

Republican Attorney Generals across the US have declared that ESG investing is a fiduciary breach because it underperforms typical historic investments, even  though they offer no proof.    While there can be bad ESG funds with poor performance, high fees and low transparency, that generally has little to do with the ESG part.  There have been over 2000 studies on the investment performance of ESG funds, with over 50% showing that ESG has a positive performance effect and 30% showing neutral results. Only 10% of the studies support the attorneys generals’ claim.[i]   

While all the factors Environment (E), Social Responsibility (S), and Governance (G) had positive factors on performance, G was the highest at over 60%.     A good example of ESG dumping losers is when S&P ESG index dumped Tesla from its index May 2022 when its price was over $317 a share and, by year end 2022, was down to 65% to $112 a share.  S&P cited governance related codes of business conduct, lack of transparent reporting on breaches, and the occurrence of corruption and bribery cases and anti-competitive practices as bases for its decision. S&P also cited Tesla’s handling of the NHTSA investigation following multiple deaths and injuries were linked to its autopilot vehicles. [ii] The dominance of single board member, as is the case with Tesla, is considered a substantial weakness in governance,

Governance has focused on corporate governance of public regulated securities.  The Council of Institutional Investors in the US has developed an extensive and effective framework for dealing with governance issues in public securities. [iii]  The CFA institute has developed an ESG certificate and curriculum, including governance, whose factors highlight overall transparency, accountability and financial integrity, as well boards independence and expertise [iv] There needs to be more upstream applications of governance in investments, first to money managers, consultants, and to the boards of retirement plans and other asset owners

As we have found out with Crypto, the structure of real asset matters. The best structure is to directly own a regulated liquid security that is transparent in your own independent custodial account. This structure allows institutions, such as CII, to have the ability to control and monitor their own individual assets and have complete transparency of the management including fees and commissions associated with trades.  Another good structure is owning a regulated liquid security within a SEC registered mutual fund.  Collective investment trusts (CIT’s) can be a good structure or a bad structure.[v] 

Like crypto, many the most vocal ESG large institutional investors have a blind spot for gof investment structure.     Private equity and hedge funds have an extreme lack of transparency and liquidity, as evidenced by the fact that it has been shown that most investors have no idea of how much they pay in fees and expenses and they even lie about their ESG attributes.  

New York State and New York City claim to have strong ESG policies. Yet they invest in have private quity firms with horrible ESG records.[vi]   Ownership via a contract has few of the protections that a registered security.  M of such firms any are domiciled in the Cayman Islands, which seems to be for the benefit of the managers.[vii]  Many of these contracts absolve the manager of fiduciary duty and push the risk onto the asset owner.

The majority of 401(k) plan investment options are in transparent SEC registered mutual funds. However, there are significant retirement assets that are not owned by participants directly, but via non-transparent and high fee annuity contracts.  These annuity contracts absolve the insurance company of fiduciary duty and push the risk onto the participants, who then have to sue the plan sponsor if they feel they are wronged.   I believe that a plan sponsor who puts participants in non-transparent annuity contracts as breaching their fiduciary duty. [viii]

Regulation does matter.   For US based asset owners, we have seen the collapse of totally unregulated investments like Crypto.   We have private equity and hedge funds that are lightly regulated by the SEC .  Federal regulation matters.   Annuities and insurance products can cherry pick the weakest state regulator among the fifty states.  CIT providers could use the Federal OCC, but mostly choose to use the weakest state bank regulator they can find.

ESG ratings of corporate governance look at regulatory violations. [ix]  Violations such as EPA fines for pollution and labor violations, are looked at by ESG analysts.   However, many retirement plan and asset owners seem oblivious to continuous violations from asset managers like Wells Fargo and others for violations that include fee gauging and fiduciary breaches. [x]

Good governance is great for investors and should be encouraged.  I think these governance principles are consistent with one’s fiduciary duties and need to be expanded.    Fiduciaries should follow solid governance by buying real stocks and bonds they can own, instead of fake assets like crypto and/or vague contracts for firms domiciled in the Caymans or regulated by the state of Iowa.   Fiduciaries using common sense governance principles should avoid companies that have been fined for fiduciary breaches by the government.   

Chris Tobe, CFA, CAIA,  was recently awarded the CFA Institute Certificate for ESG investing.  He is Chief Investment Officer for the Hackett Group, where he helps manage an ESG Racial Justice Impact Fund.


[i] https://www.tandfonline.com/doi/full/10.1080/20430795.2015.1118917

[ii] https://www.indexologyblog.com/2022/05/17/the-rebalancing-act-of-the-sp-500-esg-index/

[iii] https://www.cii.org/    

[iv] https://www.cfainstitute.org/en/programs/esg-investing/

[v] https://commonsense401kproject.com/2022/02/22/cits-collective-investment-trusts-in-401k-the-good-and-the-bad/

[vi] https://www.levernews.com/the-private-equity-black-box-pours-new-york-pensions-touting-divestment-into-fossil-fuels/

[vii] https://commonsense401kproject.com/2022/02/15/private-equity-in-401k-plans-a-ticking-time-bomb/

[viii] https://commonsense401kproject.com/2022/05/11/annuities-are-a-fiduciary-breach/

[ix] https://violationtracker.goodjobsfirst.org/

[x] https://commonsense401kproject.com/2022/07/24/401k-background-checks/

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