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)