The Corner

Economy & Business

No J in ESG?


Over at Bloomberg, John Authers takes a look at ESG funds:

Amid all the horrors of 2020, ESG ETFs have so far suffered only two weeks of outflows, both of minimal amounts. Meanwhile, when it comes to investment performance ESG has also had a good crisis. Prices are down but in all the main regions of the world, MSCI’s index of ESG companies outperformed the main benchmark during the first quarter….

As a reminder, ESG is shorthand for Environmental, Social and (corporate) Governance. An ESG ETF is a fund screened to ensure that the companies in which it invests satisfies certain environmental (‘E’), social (‘S’) and governance (‘G’) standards. The ‘G’ tends to be rather less controversial than the ‘S’ and the ‘E’, but as Authers points out, citing academic research, quite what these standards are is far from fixed:

Any number of different financial data groups offer their own ratings, while a number of investment houses have created their own proprietary versions. That competition has created confusion.

Indeed, but out of confusion comes opportunity. One of the features of ESG is the return it offers, not necessarily to shareholders (I’ll touch on performance a bit later), but to a growing eco-system of rent-seekers ranging from investment banks peddling their own ‘proprietary’ definitions of ESG, to a host of consultancies offering their services both to companies to help them comply with these standards and to investors keen to be sure that they are putting their money in the ‘right’ sort of company. This confusion is also useful to activists, particularly those pushing the ‘E’ (and particularly those focused on climate change), for whom no degree of compliance is ever enough. As those aware of the history of some of the world’s more effective cults, whether political or religious, will know, the quest for ever greater degrees of a purity that is somehow just out of reach is a powerful way of firing up the faithful and bullying the unbeliever.

Looking at performance, Authers (who is by no means unsympathetic to ESG investing) notes some research that appears to show that “ESG’s current popularity owes more to the fact that it offers a simple way to jump on the current hot stocks than to any greater desire to do good.”

For my part, I don’t think that explains why ESG is on the march. For that, I’d look at both a genuine — if often misguided — desire to insist on doing or choosing the right thing, as well (as mentioned above) at the opportunities for profit that ESG can offer those who feed off it. But it does give rise to a line of thinking which, as Authers observes, can be taken in a ‘subversive’ direction:

It is possible that ESG is undermining itself — or at least that the E and the S are in conflict with each other. Vincent Deluard, of INTL FCStone Inc., suggests that ESG funds are people-unfriendly. Tech and pharma companies tend to look good by ESG criteria, but they tend to be virtual as well as virtuous. These are the kind of companies that need relatively few workers and which churn out hefty profit margins. When Deluard looked at how the big ETFs’ portfolios varied from the Russell 3000, the results were spectacular. They are full of very profitable companies with very few employees… A further look at companies’ market cap per employee showed that investing in the current stock market darlings who are making their shareholders rich is a very inefficient way to invest in boosting employment. They include hot names like Netflix Inc., Nvidia Corp., MasterCard Inc. and Facebook Inc….

The problem, Deluard suggests, is that ESG investing, intentionally or otherwise, rewards exactly the corporate behavior that is creating alarm. Companies with few buildings, few formal employees and a light carbon footprint tend to show up well on ESG screens. But allocating capital to them leads to a deepening of inequality, and intensifying the problem of under-unemployment. On the face of it, they aren’t the companies that should be receiving capital if employment is to recover swiftly. If investors want to behave with the interests of “stakeholders” rather than “shareholders” in mind, and that is surely central to the ESG philosophy, then their current approach is directly counter-productive. No good turn goes unpunished.

Oh well. You can’t make an omelet without breaking eggs.


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