Stance Capital Founding Partner and Portfolio Manager Bill Davis joins Yahoo Finance Live to break down the outlook for ESG investing, challenges in the industry, and dark-money groups attempting to make ESG investing into a political wedge issue.

Video Transcript

JEROME POWELL: The public reasonably expects supervisors to require that banks understand and can appropriately manage their material risks, including the financial risks of climate change. But without explicit congressional legislation, it would be inappropriate for us to use our monetary policy or supervisory tools, for example, to promote a greener economy or to achieve other climate-based goals. We are not and we will not be a climate policymaker.

RACHELLE AKUFFO: That was Fed Chair Jerome Powell there yesterday with remarks on the Fed's clear role in regards to climate change, a blow to environmental activists who have pushed central banks to take steps to restrict lending to energy companies. All this as ESG funds took a hit the past year with no relief in sight.

For more on the road ahead for ESG, we have to discuss with us Bill Davis, Stance Capital founding partner and portfolio manager. Thank you for joining me in this morning. So, obviously, we've seen some of these ESG funds especially getting beaten up. In fact, 10 of the largest ESG funds by assets over the past year underperform the S&P. I believe only eight underperformed the S&P. But how hard of a sell is this right now, investing in ESG?

BILL DAVIS: Well, first, Rachelle, thanks for having me on. I don't think it's a hard sell at all. To be sure, I think the industry faces some headwinds, some of which I think are a little bit self-inflicted. For example, if you think about the S&P 500, it's a market cap weighted index. I think entering 2022, six or seven companies accounted for 25% of the index. I think now, with declines and a lot of FAANG stocks, that's down to maybe 10 companies accounting for that.

But because it's megacap concentrated and because you had stocks like Apple down, I think, 27% last year, Amazon, 50% Microsoft, 29%, and all the rest of the FAANG stocks kind of were average-- I think they averaged 50% declines, it's not surprising to see a lot of US ESG managers, who happen to be growth oriented, taking a big hit because they're simply overweight a sector of the economy that disproportionately underperformed in 2022.

So I think that is part of what has happened. And that's a big part of what's happened. I think that's also part of the challenge moving forward because in a rising rate environment, I don't think growth stocks is necessarily the place that a lot of investors want to be making big bets right now.

And that is kind of sort of self-inflicted headwinds. I think that there is a second set of headwinds that really is not a grassroots initiative. It's basically, frankly, a political ploy funded by a web of dark money or a network of dark money funders that is seeking to kind of make ESG or values aligned investing a political wedge issue. I think it's doomed to fail for a variety of reasons.

RACHELLE AKUFFO: And so to that point, then, obviously, it has become something of a political football, some critics accusing it of being woke investing if you invest in ESG. Do you expect that to perhaps get worse now that you have a Republican controlled House? How do you expect that, especially the policy surrounding it, to continue?

BILL DAVIS: I think it's mostly a bunch of noise. I mean, interestingly, most Americans don't have any idea what ESG is. Most Americans, by the way, aren't stock market investors. But the more they get educated that this is really a means of managing risk and the idea that capitalism is going to be sustainable in order to continue to be capitalism, I think that you're going to find that, number one, the more talk there is, the more confusion there is.

And secondly, the more people do get to understand what's actually going on, the more they're going to want to sign up for it. So I don't actually think that the political headwinds are going to amount to much, other than just simply a lot of noise.

RACHELLE AKUFFO: And as you look at the demographics, you are seeing that younger investors in particular prioritizing some of this ESG investing. What sort of returns, though, can we expect then in 2023?

BILL DAVIS: Well, before we get to young people as investors, they're also employees, right? So something like 60% of the US workforce is going to be made up by millennials and Gen Zers, I think as early as 2025, so three years from now. These employees are also consumers. And what they want is they want sustainability. They are for things like diversity, inclusion, and social equity. This is what they want.

So this idea that companies are being led around by the BlackRocks of the world is really completely missing the point that out of enlightened self interest, many major corporations have recognized that this is really good for business. And climate risk is an existential systemic risk that's going to affect all businesses. And it's going to affect all of humanity.

And so from a fund management perspective, being on the right side of that story and investing in companies who are doing a better job of mitigating these risks is important to younger investors, but it's becoming more important to all investors, whether they're big institutions or smaller companies.

And just to add something to what you said about the performance of the industry as a whole, in 2022, Stance Capital actually outperformed the S&P on a gross basis by over 600 basis points. We now have a nine-year track record in our US large cap strategy, which includes over 200 basis points of annualized outperformance with less risk.

So the point is that if ESG is done properly, it actually minimizes risk and invests in companies who are better positioned to weather climate related storm-- you know, storms in a figurative sense, but I suppose a literal sense, too. And it actually positions, I think, companies to be on the right side of history with employees and other stakeholders.

RACHELLE AKUFFO: Definitely keeping in mind that Stance ESG that we're taking a look at there. A big thank you to Bill Davis there, Stance Capital founding partner and portfolio manager, for joining us this morning.