ESG: THE GOOD, THE BAD, AND THE UGLY
ESG: THE GOOD, THE BAD, AND THE UGLY
As you may (or may not) have noticed, Tuesday tends to be ESG-time around here. There’s a reason for that, and maybe, someday, if you’re really good and eat all your vegetables without having to be asked, we’ll tell you about it.
In the meantime, it turns out that early-to-mid November is ESG-survey-time among those who are into that sort of thing. (Freaks.) And over the weekend, we sat down with the results of a couple of such surveys and found some interesting stuff.
The first survey we looked at was the seventh-annual Russell Investments survey of active ESG-managers. Most of what was contained in the results/report was pretty mundane – usual ESG survey stuff about how climate change is motivating investors, governance is motivating managers, and everyone wants to use the capital markets to make the world a better, happier place. But then there is this:
Our 2021 survey results demonstrate that screening is one of the most widely used tools utilized to implement a responsible investment policy in the asset management community. Screening uses a set of criteria to determine which sectors, companies or countries are eligible or ineligible to be included in a specific portfolio as a baseline investment decision. Negative screening with values or ethical-based criteria focuses on product-based considerations and tends to center on certain sectors, such as tobacco, controversial weapons and thermal coal. Norm-based screening focuses on business conduct or operation irrespective of sectors, such as United Nations Global Compact violators. Positive screening focuses on business activities that may identify firms as leaders among peers. In order to gauge the level of screening practices, we asked which screening criteria the asset managers utilize for both labeled and non-labeled sustainable strategy offerings.
The most popular screening criteria is value-based negative screening for both labeled and non-labeled sustainable strategies. Specifically, 47% of the respondents who use some form of screening criteria apply the value-based negative screening for the labeled sustainable strategies. For non-labeled strategies, the use of the negative screening practices was the highest among European-based asset managers, where the majority of them utilize negative screening criteria (even in non-labeled strategy offerings).
Pretty exciting, right?
OK, well, maybe you’re not an ESG geek like us, but this IS interesting, especially when coupled with the following, which comes from a summary of EY’s (Ernst & Young’s) recently released report on its sixth annual ESG survey:
A significant percentage of investors around the world are paying more attention to companies' environmental, social and governance (ESG) performance when making investment decisions and may divest from firms with poor environmental track records, says a survey.
According to the 2021 EY Global Institutional Investor Survey, 74 per cent of institutional investors now more likely to "divest" based on poor ESG performance, than before the COVID-19 pandemic.
We know, right? That’s CRAZY!
For those of you who may not be following, the reason that this is interesting and crazy is that it’s NOT ESG. It may seem like it is. It may sound like it is. But it’s not. Let us explain with a few excerpts from Chapter 6 of The Dictatorship of Woke Capital, titled “From SRI to ESG.”
By the early 1980s, socially responsible investment was common, was standardized, and was mostly a politically and socially conservative approach to investing. Standard screens avoided alcohol, tobacco, weapons, gambling, and pornography and appealed mostly to religious investors, especially conservative religious investors….
in the early 1990s, Suzanne Harvey, a smart and ambitious staffer in the Washington research office of Prudential Securities, partnered with her boss, Mark Melcher, the famously conservative managing director of the office, to pitch a new social investment tool to the company’s top brass. With their approval, she would create a research project within the Washington research team, dedicated to social investing. Management consented reluctantly, and Ms. Harvey soon launched the Social Investment Research Service (SIRS), which produced reports and screens on a whole host of social, political, and environmental issues. Users of the new service included both liberals and conservatives. Issues of concern ranged from the environment, women’s issues, labor relations, abortion, the treatment of laboratory animals, and pornography to compliance with the Arab boycott of Israel. While SIRS mostly used the time-tested social screening methodology, avoiding the shareholder activism of the South Africa divestment campaign, the Service nevertheless represented a significant development in socially responsible investing. It was the first analyst team in a major institutional research department dedicated specifically to social investments….
After the turn of the new century, the socially responsible investment idea gained steam, slowly but surely, for a few years, until 2005, when the United Nations Environmental Program (UNEP) commissioned a study from Freshfields Bruckhaus Deringer, a London law firm that’s been around since the mid-eighteenth century. The question UNEP wanted answered was this: “Is the integration of environmental, social and governance issues into investment policy (including asset allocation, portfolio construction and stock-picking or bond-picking) voluntarily permitted, legally required or hampered by law and regulation; primarily as regards public and private pension funds, secondarily as regards insurance company reserves and mutual funds?”
Unsurprisingly, Freshfields determined that incorporating environmental, social, and governance issues into investment policy was not only permissible but practically mandatory. Ignoring these variables, the firm insisted, was the real risk to fiduciary responsibility. “Conventional investment analysis,” the firm wrote, “focuses on value, in the sense of financial performance. As we noted above, the links between ESG factors and financial performance are increasingly being recognised. On that basis, integrating ESG considerations into an investment analysis so as to more reliably predict financial performance is clearly permissible and is arguably required in all jurisdictions.”
The following year, the United Nations launched its Principles for Responsible Investment (PRI), designed to help turn the ideas embraced by the UN and its climate and other environmental standards into practical investment decisions.
Within five years, the governments of New York, California, and Washington were requiring that insurance companies operating in their states disclose climate risk, and CalPERS, the massive $400 billion California Public Employee Retirement System, began looking at climate and water issues as “material” risks. In 2010, the SEC became involved in the issue, discussing disclosure requirements for corporations, given the existing disclosure scheme….By the middle of 2017, the ESG movement had become mainstream, as some “1,600 asset owners representing $62 trillion” signed the United Nations PRI.
The old and quaint notion of socially responsible investing, a generally conservative and morality-based position, had morphed into ESG, a much different and much more aggressive proposition altogether.
The differences between SRI and ESG can, more or less, be boiled down to two words “activism” and “coercion.” Social investing (or socially responsible investing, if you prefer) is a passive strategy. Investors decide the criteria by which their portfolios should be constructed, and they (or their advisors) screen out those companies that don’t meet the criteria. If it turns out that they already hold companies that don’t fit their criteria, they sell them, divest from them. Then they go about their lives like normal people. They don’t try to change the world or change companies that disagree with them or impose their beliefs on everyone using their wealth to do so. ESG, by contrast, is an activist strategy, which means that ESG investors are not content with aligning their values with companies that share them. Instead, they try to align companies with their values, using the leverage provided them by their wealth or position to coerce corporations to adopt their values and principles.
A good example here is Exxon-Mobil. Socially responsible investors who are concerned about fossil fuels and their impact on the climate did not participate in this spring’s annual meeting/board of directors coup at Exxon because they don’t hold Exxon stock. They either screened oil companies out of their portfolios in the first place or divested from them ages ago. ESG investors, however, led the charge against the Exxon board. Engine No. 1, the hedge fund that started the coup is an ESG hedge fund. The Big Three passive-fund managers – BlackRock, State Street, and Vanguard – are ESG asset managers, and therefore, they all leveraged their investors’ wealth to aid Engine No. 1 in its rebellious efforts.
In brief, then, socially responsible investors sat the Exxon fight out, while ESG investors started the fight, recruited an army to their side, and won the fight, coercing Exxon to adopt its values and beliefs.
So, what does it mean that both Russell Investments and EY found that large chunks of “ESG” investors are using SRI methodologies? Well, it means that these ESG investors aren’t ESG investors after all. If they’re not activists using their resources to coerce companies to adopt their beliefs, then they are NOT ESG compliant. Period.
The implications here are, quite frankly, enormous.
First, if “active” managers are using SRI techniques, then that means that the figures constantly tossed around about the massive growth of “ESG” are wildly exaggerated. The two are different animals altogether, and lumping them all together under the ESG label is deceptive. It gives the impression that all of the money flowing into socially conscious investments is also being used to coerce corporate managers and boards, forcing them to do things they otherwise might not. But if a sizable chunk of these funds is being guided by screens and divestment practices, then that impression is inarguably FALSE. In turn, that suggests that ESG is not as ubiquitous or as potent as its advocates suggest.
At the same time, however, if “active” managers are embracing SRI over ESG, then the “passive” managers – the Big Three and their competitors – actually wield far greater power in the ESG game than we had been led to believe they do, simply by virtue of the fact that there are far fewer players in the game. We already knew, of course, that these firms were incredibly powerful, given their size and their unified authority over proxy votes. But even that knowledge understated their true power. In turn, this suggests that the collusion among the large passive firms to push a single “sustainability” agenda is a far more significant problem than we thought it was (despite already thinking it was an enormous problem). It also suggests that legal/legislative remedies for this collusion are, perhaps, not as far-fetched as we once thought. Last week, we thought the Massive Passives had waaaaaaay too much influence in the new ESG-dominated investment world. Today, our concern – like their power – is far more extreme.
Among other things, now, more than ever, BlackRock delenda est.