Putting the Grift in ESG
National Review Online, March 20, 2021
On the whole, I would prefer to live in a society run by cynics rather than saints—cynics tend to be less intrusive. However, when cynics pretend to be saints, they are playing a dangerous game, as many of those on Wall Street now peddling “socially responsible” investment (SRI) may soon discover. To be clear, I have no doubt that some of those pushing for more SRI (or the closely related concept of stakeholder capitalism) are true believers. Others, perhaps the smartest, are jockeying for positions of power — and the perks that come with it — under a corporatist regime (stakeholder capitalism is essentially an expression of corporatism). Still others are simply following the ancient Wall Street practice of repackaging nonsense and selling it at a profit.
The idea that companies which are run not for their shareholders, but for a somewhat arbitrarily selected group of “stakeholders” and/or goals that someone, somewhere, has determined to be good for society will be more profitable (or less risky) than companies run with a keen eye on shareholder return is, on the face of it, absurd. Even if it were not absurd, the extra fillip that would come from doing well by doing good would be quickly reflected in the share prices of those supposedly virtuous companies, sharply reducing the potential upside for those who got into the game too late (which will likely be most investors).
Nevertheless, turning to Jason Zweig’s The Devil’s Financial Dictionary (a recent, and entertaining purchase, from which I plan on quoting fairly frequently in the next few months), I see that the first line of Zweig’s definition of a stock market is this:
A chaotic hive of millions of people who overpay for hope and underpay for value.
Harsh, but often true.
And so we come to the bubble in stocks that are considered to score highly against certain environmental (“E”), social (“S”) and, rather more rationally, governance (“G”) benchmarks. To be clear, this bubble, like all the most dangerous bubbles, has some logic behind it. There is no doubt that the actions of activists, governments and regulators can create an environment in which such stocks will do better than they would in a market without such distorting factors. And momentum, of course, helps. Jumping on a bandwagon can make sense, so long as you know when to jump off, but picking that moment is rather easier said than done. As the saying goes, no one rings a bell.
Valuations can only go so far, and even the supply of “greater fools” is not infinite.
Zweig:
It might seem surprising that there could ever be a shortage of fools in this world, but if you count on always finding one just when you most need to, you will wake up one day to find that everyone else has suddenly smartened up and the greater fool is you.
And so to the selling of ESG, and this piece by Michael Wursthorn in the Wall Street Journal:
Sustainability has been good for Wall Street’s bottom line.
Exchange-traded funds that explicitly focus on socially responsible investments have 43% higher fees than widely popular standard ETFs.
The environmental, social, and governance funds’ average fee was 0.2% at the end of last year, while standard ETFs that invest in U.S. large-cap stocks had a 0.14% fee on average, according to data from FactSet.
“ESG creates a fantastic revenue possibility for large firms,” said Dr. Wayne Winegarden, a senior fellow at the Pacific Research Institute.
Asset managers are among the biggest cheerleaders for sustainable investing. Their efforts are all aimed at capturing some of the tidal wave of money that has flowed into funds that promote things like clean energy or diversity. As a broader fee war has narrowed profit margins for money managers over the last decade, firms are looking to wring more revenue from the surge.
Even a seemingly small increase in fees can have a big impact at scale. A firm managing $1 billion in a typical ESG fund, for example, would garner $2 million in annual fees versus managing the standard ETF’s $1.4 million.
“It’s fresh, feels good and new,” said Andrew Jamieson, global head of ETF product at Citigroup Inc., of ESG. “But it’s not any different than anything else. These things aren’t any more expensive to run.”
Nearly $8 billion has flowed into a host of U.S. ESG-themed funds in just January and February, according to FactSet, putting the first two months of flows roughly on par with all of 2019 . . .
Money managers launched a record 71 sustainable mutual funds and ETFs last year, according to Morningstar.
Asset management giant BlackRock Inc. pulled $68 billion into its sustainable products last year, representing more than 60% annual growth, with more than two-thirds of that money going into its iShares ETF business.
In many respects, Larry Fink, the chairman and CEO of BlackRock, has made himself the face of ESG, issuing increasingly imperious directives setting out what he expects from the companies in which BlackRock, the largest asset manager in the world, invests or might invest.
Now’s not the time to go through his latest “letter to CEOs,” although I appreciated the customary, if perhaps debatably scientific, shout-out to the “mounting physical toll of climate change in fires, droughts, flooding and hurricanes” and Fink’s (professed, if implicit) faith in Xi, the Chinese dictator, someone who no one should trust.
In 2020, the EU, China, Japan, and South Korea all made historic commitments to achieve net zero emissions.
It is, of course, only a coincidence that BlackRock sees China as both a business and investment opportunity.
Then there was this (my emphasis added):
There is no company whose business model won’t be profoundly affected by the transition to a net zero economy – one that emits no more carbon dioxide than it removes from the atmosphere by 2050, the scientifically-established threshold necessary to keep global warming well below 2ºC. As the transition accelerates, companies with a well-articulated long-term strategy, and a clear plan to address the transition to net zero, will distinguish themselves with their stakeholders – with customers, policymakers, employees and shareholders – by inspiring confidence that they can navigate this global transformation.
For the CEO of the largest asset manager in the world to include “policymakers” (in other words, the state) as one of the “stakeholders” in private companies is an indicator of how far and how fast the corporatist advance is proceeding, an advance that bodes ill for shareholders and, for that matter, democracy.
But back to the Wall Street Journal:
For sustainability-focused investors, long-term returns aren’t certain. Last year, three out of four sustainable funds beat the averages for their broader categories, Morningstar said in a research report in January.
Much of that outsize performance owes to sustainable funds being populated with technology stocks, a general stock-market favorite in 2020 that outperformed nearly all other sectors. History suggests that performance may be more of an outlier than the start of a permanent trend.
Technology stocks happen to have, on some measures, a light environmental footprint, but that’s not why they outperformed.
Pacific Research Institute’s Mr. Winegarden crunched some numbers in 2019, finding that $10,000 in an ESG fund would be about 44% smaller compared with an investment in an S&P 500-tracking fund over a 10-year period.
Oh.
And a purely opportunistic embrace of ESG may well backfire. Not only does it help shift the parameters of debate in a direction that is unlikely to favor either shareholders or prosperity or free markets, but it also may well leave those who have embraced it open to some . . . embarrassment.
Take this article, published in USA Today:
The financial services industry is duping the American public with its pro-environment, sustainable investing practices. This multitrillion dollar arena of socially conscious investing is being presented as something it’s not. In essence, Wall Street is greenwashing the economic system . . .
In many instances across the industry, existing mutual funds are cynically rebranded as “green” — with no discernible change to the fund itself or its underlying strategies — simply for the sake of appearances and marketing purposes. In other cases, ESG products contain irresponsible companies such as petroleum majors and other large polluters like “fast fashion” manufacturing to boost the fund’s performance. There are even portfolio managers who actively mine ESG data to bet against environmentally responsible companies in the name of profit, a short-selling strategy.
In that last case, I can understand why, and not just because many of these companies are currently traded at bubble prices. A company that is making a great show of the emphasis that it puts on ESG is unlikely to be focusing as much as it should on delivering a return to shareholders. This is even more the case where management is financially rewarded for the progress it makes in delivering ESG-style objectives, something that is becoming increasingly popular in C-suites, both as a public gesture of piety and as a means of diluting the tougher discipline imposed by financial targets.
Back to USA Today (my emphasis added):
As disheartening as this reality is, claiming to be environmentally responsible is profitable. Last year alone, ESG mutual funds and exchange-traded funds nearly doubled. The investment community understandably reacted to this with cheers. But those cheers were only for fund managers and their bottom lines. No matter what they tout as green investing, portfolio managers are legally bound (as well as financially incentivized) to do nothing that compromises profits. To advance real change in the environment simply doesn’t yield the same return . . .
Oh.
In early March, my sentiments were echoed by the U.S. Securities and Exchange Commission (SEC), which announced it was creating a Climate and ESG Task Force to “proactively identify ESG-related misconduct” such as inaccurate or incomplete disclosures by funds and companies — an unprecedented move that suggests there might be abuses that have gone unaddressed.
That is a part of what has attracted the SEC’s attention, yes, and it may well cause some difficulties for companies that have either been mis-selling themselves or their investment products. But the SEC’s initiative is a part of a more far-reaching process. First the agency would like to bring some order into how E, S, and G are defined and measured. That makes some sense. Investors who wish to base their decisions, whether it’s to buy or to sell (including selling short), on these issues ought to know how much they can rely on claims of ESG compliance and on what those claims actually mean. Those who have been so loudly touting their ESG credentials will find any arguments made by the SEC to that effect extremely difficult to resist.
Sadly, the SEC appears to have wider ambitions that that. Please note this comment:
Proactively addressing emerging disclosure gaps that threaten investors and the market has always been core to the SEC’s mission.
What that will come to mean is that every company, whatever its previous stance on, say, climate change, will be required to disclose what it is doing in this area, a disclosure that will be used by activists as a cudgel to bring miscreants into line. But the ratchet will not stop there. What will begin as mandate to disclose will end up as an obligation on all companies to achieve certain standards — and those standards will inevitably become tougher as the years go by. To repeat myself, that is not good for shareholders, free markets, or prosperity.
That would not, I suspect, worry the author of the USA Today article overmuch:
Imagine the planet is a cancer patient, and climate change is the cancer. Wall Street is prescribing wheatgrass: A well-marketed, profitable idea that has no chance of curing or even slowing down the cancer. In this scenario, wheatgrass is the deadly distraction, misleading the public and delaying lifesaving measures like chemotherapy. But like giving false hope to unproven cures in the midst of a pandemic, the consequences of such irresponsibility are all too obvious. And motivation for why the industry continues to greenwash is all too obvious.
I believe we are doing irreversible harm by stalling and greenwashing. And all in the name of profits . . .
We’re running out of time and need to accept the truth: To fix our system and curb a growing disaster, we need government to fix the rules.
Once again, those who have been pushing ESG so hard (particularly where climate change is concerned) may find themselves on tricky ground if or when they dare to argue back.
So, who wrote the USA Today piece? Well, his name is Tariq Fancy, and, in the article, he explains his background:
As the former chief investment officer of Sustainable Investing at BlackRock, the largest asset manager in the world with $8.7 trillion in assets, I led the charge to incorporate environmental, social and governance (ESG) into our global investments. In fact, our messaging helped mainstream the concept that pursuing social good was also good for the bottom line. Sadly, that’s all it is, a hopeful idea. In truth, sustainable investing boils down to little more than marketing hype, PR spin and disingenuous promises from the investment community.
BlackRock?
Oh.
From the Capital Letter, March 20, 2021