A senior American Airlines pilot has filed a class action lawsuit in U.S. District Court for the Northern District of Texas over the 100,000 member, $26 billion airline pension, arguing that it is pursuing “leftist political agendas” by making investments that follow ESG (Environmental, Social, and Governance) guidelines.
He argues that the plan breaches its fiduciary duty by privileging activism on issues including race, LGBTQ+ rights, and environmentalism over financial returns, that “firms whose job is to deliver investment returns are instead weaponizing retirement funds, public pensions and other investments in pursuit of nakedly ideological goals.”
And, he says, that many employees do not “realize that their hard-earned money is being used against them.” Senior pilots especially tend not to align with the political goals of these funds. The desired action in the suit is for American to pay for gains that haven’t been realized by virtue of pursuing suboptimal investment strategies, and to stop further ESG investing.
There’s a basic point here about the tradeoff between ESG investing and financial returns, and that’s worth understanding (and I think that it ought to be a part of investing education). However this lawsuit isn’t going anywhere.
ESG funds necessarily earn lower rates of return. Any good investment that an ESG fund makes, a non-ESG fund can also make. ESG funds can’t make the good investments which go against their principles.
So what’s an ESG fund good for? Driving progress on social causes with dollars. The usual mechanism by which this works (note: this is not just virtue signaling!) is by lowering the cost of capital for ‘good’ companies (more investment, more money available and competition to make those funds available) and by raising the cost of capital for ‘bad’ companies (with marginally fewer dollars available to them). However, and this really shouldn’t be controversial:
- Social investing isn’t a free lunch. If you exclude high return investments from your portfolio that are inconsistent with your guidelines, you will have lower returns. It’s easy to confuse environmental companies delivering good returns – and even the sector outperforming others – with environmental investing not incurring tradeoffs. Non-ESG funds can invest in ESG projects because they are likely to yield strong returns! The only investments that ESG funds can invest in and non-ESG funds won’t are the ones with lower expected returns.
- ESG investing leads to higher returns for non-ESG investors. That’s by definition, since it leaves profitable opportunities on the table for others rather than competing down those returns. It’s the mathematical flip side of raising the cost of capital for companies you deem bad actors! You should be fine with that, but recognize both that you’re giving up returns and helping raise the returns for other investors who don’t share your philosophy.
- How many ESG funds actually short non-ESG companies? Most ESG funds do their work badly. If they were serious about raising the cost of capital for non-ESG projects shorting would be a necessary component of the strategy, and possibly even more effective.
- It can be possible to do more for environmental and social causes by earning more and donating rather than by imposing strict constraints on business activities. Giving up returns gives up the ability to invest in those causes.
There’s enough of an industry practice, enough industry experts who promote these funds, and enough historically strong performance in some of them that the claim the pension is in violation of ERISA law seems… implausible.
I believe it is admirable to invest with your principles, but you shouldn’t believe that you’re getting a free lunch by doing so. It’s admirable because it costs you something!
So should a retirement plan pursue goals that some of its members may not share? Maybe that’s a little harder, and similar to arguments over whether unions ought to invest member dues in political activism that runs contrary to the preferences of some members. But investors wouldn’t be better off with a standard that says trustees must focus only on total returns, because that just opens pensions to more litigation likely to… drain those pensions of returns. And investing decisions necessarily mean making choices, some of which aren’t articulable or well-documented.
This lawsuit isn’t going anywhere, and it probably shouldn’t, but maybe there’s an opportunity to engage people more in understanding what happens with pension money. Financial education is always something I can get behind.
(HT: One Mile at a Time)
I disagree with the premise that ESG investing will yield worse results than a non-ESG fund. By allowing investments in companies with poor governance, funds can get worse returns. I would hope that an fund with ESG criteria wouldn’t have invested in SVB, which is a poster child for poor governance. There are also short-term and long-term risks of investments an ESG fund would not select, which may have large lawsuits potential because of poor environmental or social practices. Assuming a non-ESG fund paid the same diligence towards ESG issues, they may still not invest in some of the investments from the full universe of available investments, or they may just ignore those concerns, leading to future risks. Given all that, ESG funds have tracked the overall market fairly closely, neither doing significantly better or worse than the overall market.
The other question is how this may impact American Airline pilots. Either they have a defined benefit plan, where American is responsible for making sure the plan is nearly fully funded, or they have a 401k-style plan. While ESG funds may be an option, they are rarely the only option in a 401k plan. If it’s a traditional pension plan, and the pilots are worried about funding, pilot salaries have an outsized influence on the ability of the airline to make timely contributions. Planning for pension increases vs salaries is best handled in contract negotiations, and it seems this was not important enough to the overall union to have played a part in their negotiations.
SO, since the person filing this suit purposefully chose to memorialize the description of a “Leftist political agenda” as a/the motivation of American Airlines, can we equally assume that this individual is/might be misusing the legal system for the purpose of promoting a popular “Rightist political agenda”???
@Mike T
And to add to your comments, would the plaintiff need to prove AA Management is “leftist” before this could go forward?
As Gary points out, there is leeway in investment strategies of almost any fund, including pension funds with fidicuiary responsibilities, and this is a good thing. Answering lawsuits from every disgruntled investor would be an unneccessary drain and a net negative. The lawsuit is going nowhere.
I am curious though to the logical conclusions of the AA pilot. Are the fiduciary responsibilities of a pension plan to it’s investors fundamentally different than those of a large, publically traded corporation? Should I have sued Google back when “don’t be evil” was their motto? Just as Gary argues that ESG inherently earns less by discounting possible investments, most likely one loses potential profit avenues by not being evil.
@ D Pilit: Very good point!! That would seem like a logical legal hurdle and the challenge would be how do you do this; what is an accepted fact based and legally recognizable standard??
@John H – on ESG funds investing in SVB
https://www.bloomberg.com/news/articles/2023-03-14/svb-exposes-lazy-esg-funds-as-hundreds-bought-into-doomed-bank
John H,
You are a dunce. Quit your love affair with ESG and your apparent correlating poor management with naughty management (like engaging in Altria’s lines of businesses). If there is a fiduciary duty (and I do not have, from this article, sufficient facts to know) if efforts to be ESG-ey contravene such a duty.
This is a good start of people fighting back against ESG.
blackrock/vanguard/ etc use OTHER peoples money to influence corporate behavior. The behavior they are trying to influence may not necessarily be better for a companies bottom line. This is slowly how socialism/communism begins to take hold. Instead of pursuing financial returns, quasi governments (blackrock/vanguard) now try to control society irrespective of financial returns. Until, eventually, there are no more financial returns and real government has to step in, print money, bail out, and now control. This has been seen before in Russia, China, Cuba, Zimbabwe, Venezuela- just never on the scale and level we are seeing in America today. It will take a generation, but you are watching the destruction of a society in real time- and there will be no winners in the end.
I’d like to know the source for “by definition, ESG investing gets lower returns.” ESG stands for environmental, social and governance. Anyone making an investment — and particularly pension funds with long horizons — must look at the long-term prospects of their investment, which, by definition, includes environmental, social and governance aspects of that investment. Is it prudent to invest in a company with poor corporate governance? Or invest in a company that ravages the environment and is likely to end up bankrupt? Or ignore social issues and suffer reputational and financial loss? The lawsuit is clearly part of the right-wing anti-woke jihad funded by certain corporate interests / billionaires. I’m surprised you’ve bought into it with the pseudo-economic analysis. This is way beneath your usual excellent work.
Jeez, Jerry. Equating ESG investing by private companies with authoritarian regimes is beyond the pale. We’re not sliding towards authoritarianism — unless Trump, MAGA republicans and the Supreme Court get their way. Changing voting laws to prevent people who won’t vote for you from voting is a slide towards authoritarianism. Chilling speech, a la DeSantis and firing people who don’t share your views is a slide towards authoritarianism. Protecting transgender people from bullying isn’t Teaching our actual history isn’t. I know the MAGA right needs to vilify and dehumanize everyone who doesn’t agree, but break out of the Fox News bubble, man. Didn’t the Dominion settlement / admission reveal anything about Fox and fellow travelers villifying anything not MAGA?
@Birny – tell me what I wrote – in terms of the logic – that is wrong? A non-ESG fund *can invest in the very same things as an ESG fund* if they are good investments! A non-ESG fund can capture all the upside! But an ESG fund is excluded from great investment returns that’s outside of its guidance. A non-ESG fund, holding quality of the managers constant, should always outperform an ESG one since they aren’t excluded from anything. ESG just means excluding certain opportunities by rule.
C;mon Gary. Lazy ESG funds as some general evidence of anything? What about the multi-millionaires and billionaires who put massive amounts in SVB despite the legal 250K deposit limit? Your anecdotes are typically amusing — when they are clearly anecdotes. Not when you try to push a broad generalization.
@Frank – when Google went public their offering documents were clear that they would not always pursue profit maximization.
Gary, your premise is flawed. You equate a smaller subset of investment options with a lower set of upside possibilities, as opposed to the smaller set of investment options excluding those with greater downside risk.. ESG investing could be winnowing the investment options to the better investments — the ones that don’t carry excessive environmental, social or governance risk. At one point, investing in asbestos companies was probably a great investment. Companies that might have had foresight to avoid that investment would not have been excluding higher-return companies, but excluding companies with poor long -term prospects. There’s a difference between investment firms that specialize in ESG and private companies and pension funds that consider ESG. This lawsuit and recent laws, like ones in Texas, want to prohibit even the consideration of ESG. The Texas and Montana laws prohibit insurers (insurers!) from considering ESG. Yes, let’s prohibit an insurer from considering environmental and climate issues as they assess risk. But, I digress.
@Birny – it’s simply another planet where only ESG companies offer good returns (and even if that were true, non-ESG funds could invest in them).
And to believe that ESG is even a particularly good proxy for well-run companies… American Airlines was added to the Dow Jones Sustainability North America Index!
Gary, we can continue the philosophical debate whether ESG funds limit upside potential or limit downside risk, but this should be an empirical question. (I didn’t claim only ESG investors get good returns, just that the realm of possibilities could just as well include ESG investors excluding low return -to-risk investments. How well do companies that consider ESG in their investments perform versus those that don’t (over a reasonable time frame)? And again, we need to distinguish between investment companies / funds — between investment funds / manager who “specialize” in ESG versus those that don’t — as opposed to regular companies (like insurers who invest trillions of dollars or pension funds) who consider ESG versus companies that don’t. Is it inappropriate to consider governance (part of ESG) when thinking about investing in Tesla? Isn’t it a legitimate investment consideration when the CEO alienates the affluent Democrats who were once thrilled by him?
Sorry, Gary, you know nothing about how the courts work.
If they filed with the below judge, as they should have, ESG is toast:
Judge Matthew J. Kacsmaryk
https://www.txnd.uscourts.gov/judge/judge-matthew-kacsmaryk
He is one of the most conservative judges in the District and since he is the only judge who sits in that jurisdiction, he gets all the cases that are filed there — excellent legal strategy and hopefully plaintiff took advantage of this.
@Hadley V Baxendale – you think the district judge would be the final word on this..?
I agree that the lawsuit is unlikely to get off the ground.
The first major hurdle would be proving that non-ESG funds always outperform ESG funds. The only way to assess and prove damages is to demonstrate that ESG funds always underperform and by how much.
History simply doesn’t back up that idea. In 2021, the S&P 500 ESG performed better than the S&P 500 by 5%, just as a salient example. That fact alone shoots the lawsuit in the foot.
We all know the stock market is a gamble. ESG funds may or may not perform better or worse depending on a multitude of internal and external factors– government policy, companies getting on board with ESG guidelines voluntarily, popular opinion towards ESG shifting one way or another, and so forth.
This all makes it impossible to prove any damages or harm. ESG is not certain to give lower returns based on both provable history and the nature of the stock market itself.
Furthermore, if it’s a matter of moral objection to investing in “woke” companies, there’s no case there either. If one person out of one-hundred thousand can sue for damages (they can’t prove) because their pension was invested in a company whose politics they didn’t agree with, it would be complete bedlam.
Long term ESG investing doesn’t seem to make sense as they would eventually invest in organizations to destroy the capitalist system of investment on the first place.
This type of Union or Pension investing is common and seems to go against fiduciary responsibility and even against the wishes of the members involved.
You’re right, this lawsuit won’t go anywhere. The plaintiff has to prove “harm” as part of their case. And this pilot, as the moving party has the burden of proving their case. The first challenge is how was he (and by extension, his fellow pilots and employees he claims to represent) harmed? A pension by definition is a defined benefit. As such, the airline owes him a certain amount of money regardless of if the pension has the money or not. Any money the fund is short must be made up by the airline. So, there is no possible way he can be harmed except if the plan is terminated, which would be the only angle, and by all respects, there is no chance of that right now, so there can be no harm. Therefore, he has no standing. This case will be dismissed on standing alone. This guy is an idiot for even filing a lawsuit since he can’t be harmed. It just represents the below average intelligence of the GOP voter these days. And his lawyer should be sued for even taking his money over a frivolous lawsuit.
On the other hand, the investors do have standing because they stand to be harmed if returns are lower and the company has to make up the difference. However, if the fund is healthy, they are not being harmed.
Funny how the people clutching their pearls and screaming about “woke liberal cancel culture” are the ones always trying to cancel everything they don’t agree with. There was a time that we taught our children that compromise was always possible and often necessary. Today, we teach that working with people you ideologically disagree with is bad. The people on both extremes are going to destroy the country for the rest of us sitting here in the middle.
The core issue is whether or not the principals (pension beneficiaries) are able to fire an agent (pension fund manager) they believe is not acting in their interests. I infer that only AA management can fire or redirect the pension fund manager. If the employees want a change, their unions should put that on the negotiating table.
@ Gary Leff,
Well above him is the 5th Circuit Court of Appeals and I will let a rag that many who have chimed in here would appear to regularly consult:
“The Trumpiest court in America
The United States Court of Appeals for the Fifth Circuit is where law goes to die.”
https://www.vox.com/policy-and-politics/2022/12/27/23496264/supreme-court-fifth-circuit-trump-court-immigration-housing-sexual-harrassment
Above them, you have the Supremes and even if Roberts casts a “no”, you would still have a 5-4 decision, so I say no slam dunk that this gets disposed of early, even if it was not filed in Amarillo.
Managers have a fiduciary duty to maximize financial gain for the beneficiaries.
Gary says ESG investing necessarily fails to maximize financial gain.
Ergo . . .
The green extreme left unions always have their agenda!!!
Well made points Birny. This highly compensated triple-dipping pilot and his cronies (probably living a life of luxury, in the Southlake, TX area), roll out their right-wing diatribe and file frivolous lawsuits like the now impeached Texas AG, who has squandered millions of our $$, that would otherwise have been spent on services that this state is in dire need of. These fat cats fail to realize that they are wasting my investment $$ as a stockholder, in suing AA. Such over-pampered goons sitting in the cockpits, fly-by-wire (and hopefully they will be redundant someday soon), and have no clue how to earn their bread the hard way.