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Your retirement savings might be working harder at looking good than doing good.
Pension funds have discovered something remarkable in recent years. They can charge higher fees, attract positive media coverage, and appease activist shareholders simply by slapping three letters onto their investment strategy: ESG. Environmental, Social, and Governance investing promises to align your money with your values while delivering competitive returns. It sounds perfect because it is. Too perfect.
The uncomfortable truth is that ESG has become less about changing corporate behavior and more about changing marketing brochures. When every major pension fund claims to be investing ethically, either we have achieved a moral revolution in finance or someone is exaggerating.
The Promise That Sells Itself
ESG investing operates on an elegant premise. Companies that treat the environment well, respect their workers, and maintain honest governance structures will outperform those that don’t. Doing well by doing good. The market rewards virtue. Everyone wins.
This narrative has a powerful appeal because it resolves a tension that has nagged at investors for generations. You no longer need to choose between profits and principles. The same companies poisoning rivers and exploiting workers are also, conveniently, bad investments. Your conscience and your portfolio can finally agree.
Pension fund managers embraced this story with enthusiasm. They could deflect criticism about funding oil companies or sweatshops while maintaining their fiduciary duty to retirees. Better still, they could launch new ESG products with higher management fees. After all, virtue requires expert curation.
But something strange happens when you examine what ESG actually means in practice. The definition becomes slippery. The measurements become questionable. The outcomes become oddly similar to conventional investing.
The Rating Game Nobody Can Win
At the heart of ESG lies a measurement problem that nobody has solved. How do you score a company’s ethics? Different rating agencies produce wildly different assessments of the same companies. A firm might rank highly on one ESG index and poorly on another. They are supposedly measuring the same thing.
This inconsistency is not a bug. It is a feature. When definitions remain vague, everyone can claim success. A pension fund can tout its ESG credentials while holding essentially the same stocks as before, just filtered through a more favorable rating system.
Consider the contradictions. An electric car company scores well on environmental criteria despite operating factories with questionable labor practices. An oil giant ranks highly on governance because it has diverse board members. A tech firm gets credit for carbon neutrality while profiting from business models that maximize addiction and polarization.
The rating agencies face an impossible task. They must reduce the moral complexity of a massive corporation into a single score. Should worker safety in overseas suppliers count more than executive pay ratios? Is a renewable energy investment more important than data privacy practices? These are philosophical questions masquerading as mathematical ones.
When measurement becomes this subjective, it becomes malleable. Companies learn to optimize for the metrics rather than the underlying values. They hire ESG consultants who teach them how to score well without changing their fundamental business model. The result is ethical theater.
The Pension Fund Peculiarity
Pension funds face unique pressures that make them particularly susceptible to ESG marketing. They manage other people’s money over long time horizons while operating under intense public scrutiny. They must appear prudent and responsible. ESG offers a readymade solution to this perception problem.
A pension fund manager can now deflect criticism with three magic words. Accused of funding climate change? We have ESG screens. Confronted about sweatshop labor? We score suppliers on social criteria. Questioned about executive excess? Governance is our middle name.
The beauty of this defense is that it sounds responsible without requiring difficult decisions. A fund can divest from the most obvious villains (tobacco, weapons, maybe coal) while keeping the bulk of its portfolio unchanged. The marketing impact is substantial. The actual impact is marginal.
Pension funds also discovered that ESG allows them to have it both ways with their beneficiaries. They can tell younger workers that their retirement savings support sustainable companies. They can tell older workers that returns remain competitive. Both claims are technically true because ESG funds often hold similar positions to conventional funds, just with different branding.
The incentive structure reinforces this dynamic. Fund managers get rewarded for appearing ethical, not for being ethical. They face career risk from obvious scandals but little consequence from subtle ones. Divesting from a controversial company generates headlines. Continuing to hold a problematic firm that maintains good ESG scores generates nothing.
What the Numbers Never Show
Here is where the story gets counterintuitive. ESG funds often perform similarly to conventional funds. The similar performance reveals that ESG has become so broad and flexible that it has lost any meaningful distinctiveness. When your ethical investment fund holds the same tech giants, pharmaceutical companies, and financial institutions as everyone else, just weighted slightly differently, you have not created an ethical portfolio. You have created a marketing department.
The really interesting question is not whether ESG funds match market returns. It is whether they change corporate behavior. Do companies pollute less because ESG funds demand it? Do they treat workers better? The evidence here is thin and contested.
Companies certainly talk more about sustainability now. They publish glossy ESG reports filled with commitments and targets. But talk is cheap, and commitments without enforcement are cheaper still. The same corporations that have pledged carbon neutrality continue expanding fossil fuel extraction. The same firms that celebrate diversity maintain pay gaps. The same executives who praise stakeholder capitalism pocket massive bonuses while laying off workers.
This gap between rhetoric and reality suits everyone involved. Companies get credit for aspirations rather than achievements. Pension funds can claim they are driving change. Rating agencies sell more subscriptions. Consultants bill more hours. Everyone benefits except perhaps the retirees who think their savings are actually making the world better.
The Exclusion Illusion
The primary tool of ESG investing is exclusion. Don’t invest in bad companies. This approach has intuitive appeal. If you refuse to fund harmful activities, those activities should become harder to fund.
The problem is that public markets don’t work this way. When an ESG fund sells tobacco stocks, someone else buys them. Usually at a slightly lower price, which means the buyer gets a better return. The tobacco company continues operating. The only thing that changed is who profits from it.
This creates a perverse outcome. ESG investors remove themselves from the most problematic companies, leaving those companies in the hands of investors who care less about their impact. The fund manager looks ethical. The company faces less pressure to reform.
Some ESG advocates recognize this problem and emphasize engagement over exclusion. Instead of divesting, they use shareholder power to push for change. This sounds more promising but faces its own challenges.
Pension funds rarely have enough shares in any single company to force change alone. They must coordinate with other investors, which means finding common ground among groups with different priorities and incentives. The resulting shareholder resolutions tend toward the lowest common denominator. More disclosure. Better reporting. Modest targets. The kind of changes companies can implement without threatening their core business model.
Meanwhile, the companies most in need of reform are often those most resistant to shareholder pressure. They have entrenched management, loyal investors, or business models incompatible with ESG principles. A pension fund can engage with an oil company all it wants. The company is still going to extract oil.
The Definition Drift
Watch what happens when you ask pension funds what ESG means to them. The answers vary wildly. Some emphasize climate exclusively. Others focus on labor practices. Some care mainly about board diversity. A few seem primarily concerned with avoiding scandals that might generate negative headlines.
This definitional flexibility is not accidental. It allows each fund to create an ESG strategy that aligns with its existing holdings and investment philosophy. You end up with ESG meaning whatever the fund wants it to mean.
The drift becomes more pronounced over time. As ESG becomes mainstream, the standards soften. What counted as ethical five years ago now seems quaint. The funds that once proudly divested from fossil fuels now invest in natural gas because it is cleaner than coal. Progress is redefined as incremental improvement rather than fundamental change.
ESG funds typically charge higher fees than conventional index funds. The justification is that ethical screening requires expertise and resources. Someone must analyze corporate behavior, engage with management, monitor compliance. This costs money.
But the evidence suggests that much ESG screening is fairly mechanical. Rating agencies do most of the analytical work. Funds simply exclude companies below certain scores or include those above them. A computer could handle this screening in seconds.
The higher fees function less as payment for actual work and more as a signal. They communicate that ESG investing is premium and sophisticated. They make the product seem valuable. They also generate substantial revenue for fund managers at a time when traditional management fees face downward pressure.
Consider the math. A pension fund with billions in assets might charge an extra quarter percentage point for ESG screening. On large sums, this adds up to millions in additional fees annually. The fund needs to justify this cost to beneficiaries. The easiest justification is impact. We are changing the world. That is worth paying for.
The Mirror We Avoid
ESG investing reveals something about what we want from our institutions. We want them to be good without costing us anything. We want virtue that pays dividends. We want to feel better without actually doing differently.
Pension funds offer us this illusion because we demand it. We want our retirement savings to grow but also to reflect our values. We do not want to choose between them. ESG promises we do not have to.
The trap is believing this is possible without sacrifice or compromise. The trap is thinking that markets naturally reward morality. None of this means pension funds are evil or ESG is entirely fraudulent. It means the current enthusiasm for ethical investing has outpaced its actual capabilities. The marketing has gotten ahead of the reality. The promise has exceeded the product.
We can demand more rigorous standards. We can support genuinely different investment approaches. We can accept that real ethics might sometimes cost us something. Or we can keep pretending that slapping ESG onto a conventional portfolio makes it ethical.
The choice, ultimately, is ours. But we should at least be honest about which one we are making.
