ESG Investing: Its Complicated
Rarely does a day go by without some sort of “ESG” investment product being thrown our way. ESG stands for investments that derive merit for their good Environment, Social or Governance habits or standards.
As such, there is a list of “usual suspects” that cannot be included in various ESG portfolios. Some of these are fossil fuels, guns, tobacco, alcohol, or labor conditions.
Although I am sure most of us can come up with a few violations of ESG standards, it is really hard to come up with a solid conclusion of what you should be looking for and how to consistently implement these ideologies.
For instance, we manage two separate foundations operating out of Texas. They are both run by intelligent and well-meaning citizens.
Foundation A said they did not want any securities tied to tobacco or alcohol. If that is what the board chooses, our job is to offer food-for-thought. Ultimately, we implement the investment strategy the governing board chooses.
Foundation B took a different approach. The were perfectly fine owning tobacco and alcohol but drew the line with companies that produced birth control.
It was an interesting conversation that highlighted the differences of opinion from twelve people living in the same community.
Foundation B wanted to liquidate a stock whose primary product was birth control. However, the next year the birth control maker was acquired by Johnson & Johnson, a large multinational pharmaceutical company. Now, the same birth control maker contributed less than 5% of the parent company’s total revenues.
Foundation B used a sliding scale to measure the impact. Since birth control products were now a small percentage of total sales, they were okay holding the parent company.
Another organization wanted to ban any company producing or using fossil fuels in their end products. Their ban not only included petroleum, but also lower carbon emitting natural gas. Although this seemed a bit extreme, it was not our decision to make.
However, the group struggled mightily once they realized that petroleum products are used in more than 6,000 different products including plastics, paints, carpet, nail polish, clothing, rope, tires and perfume.
We have also had spirited discussions focused on multi-national businesses like Apple and Nike due to the claim that their products are manufactured in sweatshops in China using child labor and poor conditions.
It should be obvious that ESG investing is anything but straight forward. It is a very personal and customized decision. There are numerous conflicting goals and issues when you weave morality, ethics, religion and politics into your investment decisions.
Furthermore, all businesses employ humans. Humans are very flawed. They may make good products, but it doesn’t stop them from engaging in bad behavior. And a company may make bad products, but it doesn’t mean their people are bad.
The goal of supporting businesses that do good for society is easy enough. Unfortunately, this is not a clearly defined issue and there is no commonly accepted manner by which to deploy ESG standards.
There are several rating firms that assign ESG assessments. Unfortunately, they cannot decide what ESG should look like either. Of the six large rating firms, they only agree on about 60% of their ESG conclusions.
As such, ESG investing sounds good in theory but remains very hard to implement. It means different things to different people.
The ESG argument is pretty close to politics or religion. It is highly personal and there is no conclusive right or wrong. Whatever works for you still presents a variety of outcomes, trade-offs, and consequences.
Even the Department of Labor has weighed in on the matter stating that ESG investing violates fiduciary mandates. The DOL states that the fiduciary mandate for underlying pension or retirement plan participants cannot come second to ESG mandates.
I also have a more skeptical view of why ESG is becoming popular. The ESG category gives fund companies and investment firms another product to sell. A different product allows them to cater and market to different groups.
If you follow the money, you will often identify people’s motives. It is estimated that more than $30 trillion in assets are invested based upon ESG mandates.
Bluntly, if you dangle $30 trillion in front of Wall Street, they will conjure up a product to sell. Given this, I question whether true care, concern and compassion is hard at work, or is this just another way in which Wall Street separates people from their money with the “new product of the day.”