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“The value of assets managed with a responsible investing framework has risen to $A1.54 trillion, accounting for 43% of the total (Australian) market,” The Australian reported on 12 September.
In a survey it released that day, the Responsible Investment Association Australasia stated that $2.06 trillion of assets under management had been “self-declared as practicing responsible investment.” Tellingly, however, in research that it conducted for the RIAA, EY excluded “some $521 billion (of this amount), which failed a scoreboard of measures.”
RIAA’s survey also found that “performance concerns were the strongest deterrent to the responsible investing market … A lack of trust and concerns about greenwashing (giving a false impression or providing misleading information that a company or its goods and services, or a fund’s investments, are more environmentally kosher than they actually are) were also significant deterrents.” Yet a “climate change and sustainability services partner” at EY remains undeterred: “as a wave of mandatory reporting and product disclosure regimes comes into force, understanding the current state of the market and the range of approaches being adopted by responsible investors is critical.”
This article highlights five hard truths which ESG’s enthusiasts obscure or refuse to acknowledge:
According to Investopedia, “Environmental, social and governance (ESG) criteria are sets of standards for a company’s behaviour used by socially-conscious investors to screen potential investments.
Environmental criteria considers how a company safeguards the environment, including corporate policies addressing climate change. Social criteria examines how it manages relationships with employees, suppliers, customers and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights. ESG investing is sometimes referred to as sustainable investing, responsible investing, impact investing, or socially responsible investing (SRI).”
On 22 June 2021, Terence Corcoran, a columnist and comment editor at Canada’s National Post (that country’s counterpart to The Australian), provided some key background information:
I discern two variants of ESG. The first, which I dub “soft ESG,” seeks to devise criteria, measure companies against them and inform investors about companies’ operations in relation to these standards. Investors can then, if they’re so minded, adjust their portfolios accordingly. What I call “hard ESG,” in sharp contrast, seeks (initially by suasion and hectoring and subsequently by legislation and regulation) to compel companies and investors to conform to these standards.
The intolerable problem for hard ESG’s zealots, like “climate emergency” extremists, is that apparently too few shareholders are sufficiently fussed. They’re declining to choose as ESG’s enthusiasts demand; therefore they must lose their right to choose – and ESGers’ dictates must be imposed.
Yet ESG is powerful – and becoming more so all the time. During the past several years, asset management companies and brokerage firms have offered ever more exchange-traded funds (ETFs) and other financial products that claim (but see below) to follow ESG criteria. ESG is also influencing – and in a few cases determining – the investment choices of large institutional investors such as public pension funds in the U.S., superannuation funds in Australia and sovereign wealth funds in a few other countries.
According to a recent (2020) report from the SIF Foundation, at the end of 2019 investors held $US17.1 trillion in assets chosen according to ESG – compared to $US12 trillion in 2017. Earlier this year, Bloomberg Intelligence projected that more than one-third of all globally managed assets, amounting to more than $50 trillion, could carry explicit ESG labels by 2025.
“As ESG-minded business practices gain more traction,” Investopedia concludes, “the ultimate value of ESG criteria will depend on whether they encourage companies to drive real change for the common good, or merely check boxes and publish reports. That, in turn, will depend on whether the investment flows follow ESG criteria that are realistic, measurable, and actionable.” As we’ll now see, these criteria are none of these things.
ESG’s advocates seldom express their starting point explicitly. That’s probably because most of them regard it as so obvious that it doesn’t need to be stated; but perhaps it’s because a few of them recognise that, if it were expressed openly, it’d be evident to many people that it’s highly doubtful – and therefore that ESG as a whole rests upon a weak foundation.
There’s certainly no shortage of entities that purport to devise ESG criteria and measure corporations against them. These entities include global accounting giants and investment institutions as well as national and international ratings and standards-setting agencies.
A key fact – namely that no ESG accounting or investment standard exists – doesn’t trouble them. One global accounting firm claims not merely that such a standard will be developed; once devised, it “will empower companies, providing objective data that reinforces the value of the work being done to build an organisation’s long-term value and sustainability. Within a short period of time, it’s likely that ESG metrics will become an expected part of a company’s financial reporting and an essential tool in measuring a company’s worth today, tomorrow and in the future.”
That’s clearly wishful thinking: even if devised and adopted, which is hardly certain, such standards certainly won’t provide objective data. As Corcoran notes,
ESG’s enthusiasts occasionally and grudgingly accept that difficulties exist, but always insist that ESG is in its infancy, and that as time passes its inconsistencies and even contradictions will subside. Indeed, a few advocates have asserted that, just as bond ratings agencies’ measures of credit and default risk converged over time, strong commonalities of ESG ratings firms’ measurements will also emerge.
According to The Wall Street Journal (12 September), “Composite ESG scores – which attempt to summarise all material ESG risks into a single number or grade – convey little actionable investment information. ‘I have not seen circumstances where combining an analysis of E, S and G together, across a broad range of companies with a single rating or score, would facilitate meaningful investment analysis …’ said former Securities and Exchange Commission Chairman Jay Clayton during a March 2020 SEC hearing. A case in point: Tesla’s current ESG scores by two leading rating agencies are below those of Pepsi. Does this mean electric vehicles are worse for the planet than soft drinks, or that socially concerned investors should overweight Pepsi and underweight Tesla in their portfolios? ESG ratings are all over the map because the underlying assumptions, methodologies and data inputs vary widely among ESG rating agents.”
And speaking of Tesla: should ESG’s advocates laud it for reducing society’s reliance upon internal-combustion engines? Or reproach it for squandering electricity generated from fossil fuels on Bitcoin, and relying upon batteries made with lithium – which can be hazardous (not least to the ancestral lands of indigenes in Australia and South America, which enthusiasts of ESG presumably respect) and difficult to recycle? Severe quandaries afflict most other companies – including the “World’s Most Responsible Company” (see below)
As an example of ESG’s innate and inescapable subjectivity, I give a weighting of precisely 0.0 to ethnic, gender and racial diversity. Whether a board or workforce contains 0% or 100% women (or Aborigines or Asians or …) is a matter of utter indifference to me. Others, however, weight heavily the board’s ethic, gender and racial composition. Indeed, in growing and powerful quarters “diversity” and “governance” have become near-synonyms. More generally, to emit CO2 and allegedly “exclude” certain demographic categories consigns a company to ESG purgatory.
In sharp contrast, and for a bracing dose of common sense and a deep breath of fresh air, consider Warren Buffett’s criteria for the appointment of directors to Berkshire Hathaway’s board. In its Annual Report (2006) he stated:
On 2 December 2020, the editorial board of The Wall Street Journal went further: some ESG criteria are absurd to the point of risibility:
As ESG scores and ratings attach themselves like barnacles to many investors’ portfolios, researchers are examining the factors that enable companies to receive high scores and good rankings – and improve them over time. Studies find that companies’ size and location influence their scores: larger companies get higher rankings than smaller ones, and developed market companies getting higher scores than those in emerging markets.
ESG’s parallels to the “corporate governance” movement of the 1990s and early-2000s are uncanny – and should greatly concern investors. During those years, consultants rushed to devise principles of governance, and accountants and regulators added hundreds of pages of disclosure and myriad other rules. Proponents of corporate governance congratulated themselves that, thanks to their efforts, shareholders benefitted.
At that time, it was the biggest bankruptcy in American history. By that time, it had become clear even to some of its boosters that institutionalised and systematic deception had long sustained it. Since then, Enron has become synonymous with corporate fraud and corruption – that is, with abysmal and even criminal corporate governance.
How did advocates of corporate governance manage to overlook these egregious malpractices? According to Wikipedia, the Enron scandal “also affected the greater business world by causing, together with (an) even larger fraudulent bankruptcy (WorldCom in 2002), the dissolution of the Arthur Andersen accounting firm, which had been Enron’s and WorldCom’s main auditor for years.”
Enron: the Smartest Guys in the Room is a 2005 documentary based upon the best-selling 2003 book of the same name by Fortune reporters Bethany McLean and Peter Elkind. “Why did no one see it coming?” was the disarmingly blunt question asked by Queen Elizabeth in the aftermath of the GFC.
The fact that “corporate governance” initially enriched many of its advocates but eventually left shareholders mostly poorer – some of them much poorer – should provide a salutary warning to ESG’s partisans and investors as a whole. So should the fact that, according to Forbes (2 May 2021), Warren Buffett and Charlie Munger “certainly aren’t leading the charge on ESG investing.” Alas, these key facts probably won’t trouble most investors – until it’s too late.
“Good” (high ESG score) companies, ESG’s advocates hint – and sometimes explicitly assert – grow their revenues faster, are more profitable than and are less prone to key risks than “bad” (low ESG score) ones. (Note the unstated – perhaps because it’s obviously logically invalid – assumption that companies that possess a high subjective ESG score are normatively good, and that low-ESG companies are ethically bad. It’s clearly illogical because it conflates a subjective assessment and a normative judgment.)
In his (in)famous article (“The Social Responsibility of Business Is to Increase Its Profits,” The New York Times, 13 September 1970), Milton Friedman encapsulated the paradigm of shareholder capitalism. Warning against the dangers of “corporate social responsibility,” Friedman argued that the chief duty of business was “to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception …” Friedman rightly emphasised that, in a market economy, profits represent value created for customers. Corporations exist in order to operate profitably and thereby to serve their customers – and not to advance authoritarian agendas. In their capacity as corporate officers, businessmen would do the most good by focusing upon their bottom lines.
Does ESG Improve Corporate Outcomes?
ESG, allege its advocates, will benefit companies in one or more of at least four ways: It will increase (1) a revenue and (2) profitability, and reduce (3) risk of catastrophe and (4) cost of debt. A large and fast-growing literature investigates the effect of ESG upon companies’ operations. As I read it, the evidence that ESG has a positive effect is weak at best, mostly inconclusive and certainly not compelling.
There’s some evidence that it doesn’t pay to be a low ESG score company: such a score increases the cost of funding and insurance. Significantly, however, most of this evidence comes from fossil fuel producers (many of whom have been forsaken by bankers and insurers) and “green” energy outfits (all of whom have been lavished with government subsidies).
Does ESG Lift Investors’ Returns?
ESG’s partisans often imply (and occasionally state overtly) that investors whose portfolios comprise mostly “good” companies and few “bad” ones generate higher returns than conventional portfolios. ESG, in other words, implies that you can simultaneously do well and good.
Even assuming that ESG can be reliably and validly measured – which it can’t – this premise, too, is fatally flawed.
If you seek to generate “excess” returns, you must first ask yourself: do others also perceive the value that I perceive? As a result, do market prices already reflect these perceptions? That, in brief, is why a high-growth company, or one in a high-growth industry, etc., typically doesn’t produce excess returns (see in particular Do tech stocks really outperform their value counterparts?): others have already spotted what you purport to (fore)see; the market has already incorporated quality management, prospects for growth, etc., into prices.
Bearing these points in mind, three possibilities emerge.
The second possibility is, from ESG-boosters’ point of view, even more disappointing:
Thirdly, only if its advocates underestimate ESG’s benefits (which I believe is doubtful) will investments in “good” companies generate higher risk-adjusted returns.
What say empirical analyses? Multiple studies conclude that investors who follow ESG strategies don’t do much good; nor do they do particularly well. According to Terrence Keeley, a former senior executive at BlackRock (The Wall Street Journal, 12 September),
Elroy Dimson, Paul Marsh and Mike Staunton (The Journal of Portfolio Management, November 2020) agree:
“You need to understand two fundamental facts about ESG or ‘sustainable’ investing,” says Jason Zweig (“You Want to Invest Responsibly; Wall Street Smells Opportunity,” The Wall Street Journal, 16 April 2021). “First, ESG is in the eye of the beholder; one investor’s paragon is another’s pariah. Second, ESG is the last best hope for investment firms seeking to hang onto fat fees.” Zweig continues:
“Asset managers are rescuing underperforming vehicles from oblivion by converting them to a sustainable approach. One in six ESG funds has been retrofitted out of a pre-existing, often struggling strategy, according to Morningstar; last year, 25 portfolios became born again as sustainable funds. Investors, it seems, are more likely to put up with low returns and high fees if you enable them to feel righteous.”
Table 1: Carbon Transition – or Carbon Copy and Greenwashing?
As an example, Zweig compares two of BlackRock’s funds: its U.S. Carbon Transition Readiness ETF and its iShares Russell 1000 ETF index fund. Table1 compares their top holdings and their portfolio weightings, as well as their fees. Which is the ESG fund?
The goal of the U.S. Carbon Transition Readiness ETF, the global product head for iShares and index investments at BlackRock told Zweig, is “to change corporate behaviour” by “rewarding the winners and going light on the potential losers” in the “conversion to an economy that consumes less carbon (sic).” The result, Zweig deadpans, “is a basket of stocks the average investor might find indistinguishable from the market as a whole.”
The Carbon Transition ETF’s top seven companies, totalling 20.2% of total assets, are Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT), Amazon (NASDAQ: AMZN), Facebook (NASDAQ: META), Google’s parent (NASDAQ: GOOG - Alphabet), Tesla (NASDAQ: TSLA) and Berkshire Hathaway’s Class B (“baby”) shares. After a fee waiver, the fund charges 0.15% in annual expenses. Its sibling, iShares Russell 1000 ETF index fund, holds the identical top 7 companies, in precisely the same order and in very similar weights, and at 20.1% of total assets, for an annual expense of only 0.03%. That’s just one-fifth of the (allegedly) ESG fund’s! “So the Carbon Transition fund looks a lot like a carbon copy of a broad-market index, but with (much) higher fees.”
In other words, and like climate change alarmism, is ESG merely another means to distract attention from advocates’ greed and hypocrisy? It seems that some people who loudly proclaim that they want to “change the world” are quietly doing quite well for themselves.
Why have many corporations welcomed the immense push towards ESG? Why has a torrent of funds flowed into ESG-friendly asset managers’ coffers? To answer these questions, we simply need to ask: “Cui bono?” Who benefits? We’ve seen that companies as a whole don’t benefit; nor do their shareholders – indeed, they’re net losers. In sharp contrast, the more they imbed an “ESG culture” into corporations, the more ESG rankers, score managers and consultants benefit; the more numerous and onerous are ESG disclosure requirements, the more accounting and audit firms benefit; and the greater is the number and size of ESG funds, the more their managers benefit.
One insightful blogger (Musings on Markets, 14 September 2021) adds:
On a personal but highly relevant note, I’ve been privileged to know people who’ve actually done genuine good. Their activities and personalities differ greatly, but they all share one crucial trait: they constantly do good, but they never talk (let alone brag) about being good or hector other people about morality. That, I think, is a key reason why so many people from so many walks of life rightly mourn the death of Queen Elizabeth II.
This key distinction extends to companies and investment funds: I’m deep sceptical about companies and executives that trumpet, in their reports, regulatory filings, public statements, etc., how much “difference” they purport to make and how much “good” they allegedly do. The American journalist and writer, H.L. Mencken, hit the nail on the head. “The urge to save humanity is almost always only a false-face for the urge to rule it. Power is what all messiahs really seek: not the chance to serve.” Elizabeth Regina, requiescet in pace.
According to the ABC (“Patagonia Founder Gives Away $4.4 Billion Company so All Profits Will Fight Climate Change,” 15 September), “Yvon Chouinard, the billionaire founder of the outdoor apparel brand Patagonia, is giving away the company to fight the climate crisis.” Mr Chouinard, who has a net worth of $US1.2 billion, is transferring his family’s ownership of the company to a trust and a non-profit organisation. “Each year, the money we make after reinvesting in the business will be distributed as a dividend to help fight the crisis,” he wrote on the company’s website on 14 September.
The ABC’s report concluded: “While rich individuals often make financial contributions to causes, The New York Times said the structure of the Patagonia founder’s action meant Chouinard and his family would get no financial benefit – and in fact, would face a tax bill from the donation.”
Devon Pendleton and Ben Steverman of Bloomberg disagree. In “Patagonia Billionaire Who Gave Up Company Skirts $700 Million Tax Hit” (16 September), they state: “Yvon Chouinard structured the transfer of his firm in a way that keeps control within the family and avoids hundreds of millions of dollars of taxes.” He “won’t have to pay the federal capital gains taxes he would have owed had he sold the company.” Moreover, he also avoids the U.S. estate and gift tax of 40% when his company was transferred to its heirs.
Ray Madoff, a professor at Boston College Law School, told Bloomberg: “We are letting people opt out of supporting all the expenses of government to do whatever they want with their money. This is highly problematic from the point of view of democracy, and it can mean a higher tax burden for the rest of Americans.” Ellen Harrison, a tax attorney at McDermott Will & Emery in Washington, confirmed to Bloomberg that, far from “giving the firm away,” the transaction allows Chouinard and his family to sustain their control of Patagonia.
On 21 September 2021, The Green Market Oracle outlined “10 Reasons Why Patagonia Is the World’s Most Responsible Company.” Reason #2 is “transparency.” “There was never an ask from the Chouinard family that we avoid taxes” when structuring the transaction, said a Patagonia spokeswoman. Nor, however, did any mention of its enormous tax advantages to the family appear in Chouinard’s and Patagonia’s self-congratulatory statements. Says GMO: “Patagonia welcomes constructive criticism that is part of the growing transparency movement at the core of sustainability.”
The American Petroleum Institute has obliged. It observes (“Patagonia and Petroleum,” 16 April 2019) that “Patagonia’s view of petroleum is conflicted. While the company is against fossil fuels on climate grounds …, it also is forthright about the use of nylon and polyester in parts of its product line – acknowledging that both are made from petroleum.” Patagonia rightly contends that there’s no alternative:
In other words, Patagonia denies others’ right to consume fossil fuels (“they’re causing climate change!”) but defends its right to do so (“we can’t do without them”). API concludes “Petroleum-based materials are a big reason Patagonia’s products are what they are: light-weight, water-resistant – even life-saving. We’d argue the varied uses of petroleum in manufacturing are part of what make natural gas and oil great, now and in the future.”
ESG and related notions (corporate social responsibility, ethical investing, impact investing, socially responsible investing and sustainable investing) are fatally flawed. They fail investors, businesses and society as a whole – but reward a small coterie of advocates. ESG is internally incoherent, and its enthusiasts’ conceptions of “ethics” and “responsibility” reflect a growing authoritarian (and hypocritical) streak in Western societies.
I’m hardly the first person who concludes that ESG and related notions are fatally flawed. More than 50 years ago, Milton Friedman belled the cat: “Businessmen who talk (the language of corporate social responsibility) are unwitting puppets of the … forces that have been undermining the basis of a free society …”
Similarly, I’m hardly the only person today who regards ESG and the like as fatally flawed. Zero Hedge, in a series of articles over the past few years, has lambasted it as a “fraud,” “scam” and worse; the editorial board of The Wall Street Journal has ridiculed it as “absurd;” and Warren Buffett regards ESG reporting as “asinine.” Terence Corcoran of Canada’s National Post rejects it comprehensively: it is “a wildly unscientific agglomeration of investment models that have no consistent basis in fact or data, no measurement systems, no objective standards, no consistent rating systems and no clear accounting standards.”
Like the aforementioned astute blogger, “more than ever, I believe that ESG is not just a mistake that will cost companies and investors money, … but (also) that it will create more harm than good for society.” Terrence Keeley, a former senior executive at BlackRock, gets the last word – and issues a challenge:
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After concluding an academic career, Chris founded Leithner & Co. in 1999. He is also the author of The Bourgeois Manifesto: The Robinson Crusoe Ethic versus the Distemper of Our Times (2017); The Evil Princes of Martin Place: The Reserve Bank of...
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