The risk of woke investing

People should be free to invest their own money according to their values—that’s the advantage of our free market system. For years, many Christians have supported socially responsible investment strategies that ensured they were not supporting companies that violated their religious beliefs. After all, God calls us to steward our wealth prudently, not merely to maximize profit at all costs.

Thus, the recent explosion of interest in “environmental, social, and governance” investing might finally seem to be a broader recognition of this vision. Many aspects of ESG point to laudable goals, including caring for the environment or improving diversity. The problem is how these goals are defined and scored.

But recent political developments highlight a potential risk that powerful actors will impose one set of ESG values on all companies and investors without acknowledging the validity of different opinions.

More investment funds now focus on companies that prioritize ESG criteria, and money in these funds has more than doubled in the past year, while the number of funds has quadrupled over the last decade. In addition, a broader definition of “sustainably invested assets” finds more than $30 trillion invested globally as of 2018.

Though ESG rating systems try to  score companies objectively on dozens of metrics, the final scores are driven by the (somewhat arbitrary) weights assigned to each of these variables. (The Economist compared the scores of two leading ESG rating systems and found that companies that scored high on one rating system were not very likely to score high on the other.) These rankings and other similar scoring systems could soon become powerful tools for the largest investment funds to enforce their vision of ESG on companies.

Some of these metrics are not controversial, especially those on the “G” (governance) side. For example, it’s generally agreed that companies should have structures to prevent corruption or a clear process for reporting ethical violations. Recently, the “E” (environmental) metrics have also received considerable attention after the Securities and Exchange Commission announced unprecedented new disclosure rules for companies on their greenhouse gas emissions.

The largest potential for controversy will likely come from the “S” (social) metrics, especially if the SEC also announces rules on these. Social metrics are often quite vague, but S&P Global advises investors to consider a “company’s strengths and weaknesses in dealing with social trends, labor, and politics.”

The key question is who will decide which political engagement gets rewarded in the rankings and which gets punished. Already, large companies are taking increasingly public (and quite calculated) positions on controversial political issues that don’t necessarily align with the beliefs of their employees or the broader American public, even when these issues are entirely unrelated to the company’s core mission.

For example, in 2021, Atlanta-based companies Coca-Cola and Delta Air Lines publicly criticized a Georgia voting rights law that required voters mailing in ballots to include an ID number. When Florida recently passed a law limiting instruction on sexual orientation and gender identity to kindergarten through third graders unless it is “age-appropriate,” hundreds of completely unrelated companies, including Starbucks, Pinterest, and Nordstrom, signed a public petition opposing it.

The social score of certain industries can also change quickly based on political circumstances. When Russia invaded Ukraine, some funds that had previously blocked investing in defense companies suddenly changed course to support Ukraine. How’s that for performance-based virtue signaling?

Though most political issues aren’t yet part of official ESG metrics, it’s easy to see how activists could soon quantify and score companies that publicly align with their political beliefs. “By jettisoning the passive and ‘voluntary’ nature of social investments, ESG promises that by being active and coercive, it can also be more effective in accomplishing specific political goals,” argues Stephen Soukup, the author of The Dictatorship of Woke Capital.

People should be allowed to reasonably disagree on what counts as desirable ESG practices, but as we’ve seen in other fields, dissent from the consensus opinion is now rarely tolerated. Robert Netzly, the CEO of faith-based Inspire Investing, says that ESG databases and rankings “routinely refuse to include many faith-based ESG funds” because they “do not toe the progressive party line on issues such as diversity and bioethics.”

The debate will likely continue to accelerate over the coming years as the pressure intensifies for businesses to address specific social issues. Individual investors should have the right to invest based on their values. But in a free market, companies and investors must have the right to decide what those right values should be.